Four Best Financial Resolutions for 2013

This article published with permission from InvestmentU.com.

This is the time of year for making New Year’s resolutions. And I have four that are guaranteed to make your portfolio bigger, fatter and wider a year from now.

So listen up:

1. Save more

All investment begins with saving. And unlike the performance of the stock market, saving is something that’s under your control. It will also have a significant impact in the long-term value of your portfolio. For example, let’s say you’ve accumulated a portfolio worth $100,000. If it compounds at no more than the long-term return of the S&P 500 — 11% a year — it will be worth $1.358 million in 25 years.

Not bad. But if you added $500 a month along the way, it would grow to more than $2.1 million.

In The Millionaire Next Door Thomas T. Stanley and William D. Danko reported that affluent individuals tend to follow a lifestyle conducive to accumulating money. The seven common denominators among those who build wealth successfully are:

1. They live well below their means.

2. They allocate their time, energy and money efficiently, in ways conducive to building wealth.

3. They believe that financial independence is more important than displaying high social status.

4. Their parents did not provide economic outpatient care.

5. Their adult children are economically self-sufficient.

6. They are proficient in targeting market opportunities.

7. They chose the right occupation.

2. Pay less

When it comes to investing, expenses matter. A lot. Investment costs often get out of hand when markets are soaring and your portfolio is rising. But even then high trading costs, front- and back-end loads, high management fees and other investment costs can eat away at your portfolio like termites in an antebellum mansion. Know what you’re paying. Make sure it’s competitive.

And if you don’t know what you’re paying, ask. As a rule, more than 90% of retail clients don’t know their total investment costs because a) they’re often hidden and b) they feel awkward asking. Ask anyway.

3. Check your asset allocation

Your asset allocation — how you divide your portfolio up among stocks, bonds, gold shares, real estate investment trusts, cash and so on — is your single most important investment decision.

If you doubt it, consider this:

Let’s say you have a portfolio that is 25% stocks and 75% bonds and I have one that is just the opposite, 75% stocks and 25% bonds. At the end of the year, let’s say stocks are up 10% and bonds return 2%. But perhaps you are a great stock picker who doubles the market’s return while I own a boring S&P 500 index fund that generates only the market’s return.

Even though you are a far better stock picker, my portfolio gives a higher annual return than yours because my asset allocation was better.

In short, get your asset allocation right first. All your investment decisions should flow from that. What should your asset allocation be?

The Oxford Club recommends 30% each in U.S. and international stocks, 10% each in high-yield bonds, short-term corporate bonds and TIPS (inflation-adjusted Treasuries), and 5% each in REITs and gold shares. This should lead to higher returns with less risk.

4. Keep a sharp eye on taxes

A recent Vanguard study found that the average investor surrenders 2.5% in taxes each year. Yet many, if not most, of these tax liabilities are avoidable. How do you keep your taxes minimal without raising eyebrows at the IRS?

You follow basic tax management strategies. Stash away as much as possible in tax-advantaged retirement accounts such as traditional IRAs and 401(k) plans so that you get a break on any pre-tax contributions you make and enjoy tax-deferred earnings until you begin to withdraw the assets.

Also, keep tax-inefficient investments — like high-yield bonds, REITs, utilities and actively managed stock funds — in your retirement accounts. And put tax-efficient investments — like index funds, long-term stock holdings and municipal bonds — in non-qualified accounts. (This is known as your asset location strategy.)

Also, hold investments for 12 months or longer where possible to qualify for long-term capital gains tax treatment. And don’t forget to offset realized capital gains with capital losses in your portfolio where possible.

(I should note that we are likely to see many changes in the tax code as we pass the fiscal cliff, so I plan to revisit this topic soon.)

Conclusion

In sum, these four resolutions should form the foundation of your personal investment strategy. They will get you off on the right foot in 2013. And we here at Investment U will have many more cost-saving, tax-reduction and money-making ideas to share with you in the weeks and months ahead.

So start getting your financial house in order … and let’s look forward to a happy, healthy and prosperous New Year!

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.