We’ve seen plenty of turmoil in the financial market in the last several years. The market meltdown in 2008 destroyed trillions of wealth, causing many investors to run for the hills. As painful as 2008 was, we can now look back and be reassured that our core principles held true. Asset allocation matters.
Four years after the market crash, the broad market had not only recovered its losses but had reached new highs. Though, the investors who had bailed at the bottom didn’t get to share in the good times.
That said, financial markets continue to change, and our advice continues to evolve. Individual securities often capture the headlines; these fundamentals are the most important keys to your success as an investor.
First of all, don’t time the stock and try the market.
It’s understandable to want to be in the stock market when it’s going up, and out when it’s going down. The problem is that virtually none of us, even the most experienced investor, can accurately predict how much and when the market will move in a particular direction.
Understand the definition of risk.
As investors, we know that the potential for higher returns comes with greater risk. The combination of investments, or, more specifically, the combinations of categories of investments is called the asset allocation. Diversification is a fancy term for how you divide your money into different categories such as stocks, bonds, real estate, cash and commodities, and which specific investments you buy with each of those categories.
One way to reduce investment risk is to diversify between companies and asset classes – the old split your eggs up into different baskets concept. Asset allocation and diversification are crucial to your long-term success as an investor. We’ve experienced three major bear markets over the past two decades, and as painful as these times were, diversified portfolios fared much better.
See, there are multiple levels of diversification at work here: dividing your money up between different types of assets, and dividing your money up between the various investments within an asset class.
Investing like a pro is complicated. Once you have built up some wealth, and you know that you’re going to be relying on your portfolio for your “paycheck” in the not too distant future, there’s more to think about.
How should you build your portfolio?
As an investor, we shouldn’t overestimate our ability to handle downturns. The market will go up, and then it will go down again.Great if you’re working with a local financial advisor! Let them sweat the details, so you can focus on the big picture. If you’re investing on your own, or you want to engage your advisor in some good discussions, let’s go…
Traditional investing wisdom says that the older you get, the more conservatively you should invest (moving money out of stocks and into bonds and cash). Inflation can dramatically erode purchasing power over long periods of time.
The best asset allocation is the one that is right for you. Once you’ve settled on an asset allocation, you’ll need to select the individual investments. Vanguard, iShares and many other providers have very low-cost ETFs that will provide a basket of different investments in alignment with the assets within your allocation.
Of course, I can’t cover every aspect of investing in the space we have here– entire encyclopedias have been written on the subject! But hopefully, this has given you a good head start in the right direction. If you have any follow-up questions, contact me.