By Mark Knackendoffel on September 23, 2014
Many investors believe the keys to success are forecasting market trends and properly timing markets, either by themselves or with their advisors. Unfortunately, these investors are focusing on the wrong objectives.
Sure, there are countless investors and advisors who, from time-to-time, have gotten lucky with a market call or forecast. Such a decision may have even been based on some solid fundamental analysis. But, over the long term, this strategy doesn’t ensure financial success.
Instead, at The Trust Company, we follow a few basic principles of prudent investing that enhance the statistical probability that investors will achieve their financial security. The past several decades have been volatile, both up and down, but that has just strengthened our conviction that these principles work. Whiplash investing to meet daily market fluctuations does not.
Personal Risk Assessment
First, make an honest assessment of your ability and willingness to take on risk. Are your goals short- or long-term, or perhaps, some of both? How much cash income do you need? What allows you to sleep at night without worrying about your portfolio or your financial future? That’s our “pillow test.”
Next, you should set an asset allocation that reflects that ability and willingness to take on risk. Set specific percentages of core stocks, bonds, cash, and even other real and strategic asset classes. This is perhaps the most important step in protecting your portfolio from market drops and taking advantage of market gains.
During the recent recession, long-term growth investors with sizable equity allocations were mostly unfazed by the drop, and continued to save and invest at cheaper prices. Likewise, investors who focused on generating income were largely insulated from the stock market drop. Their interest- and dividend-paying portfolios just kept cranking out income, so the prices of securities were somewhat irrelevant because they weren’t compelled to sell to fund their cash needs.
Market Timing and Forecasting
Investors will help themselves by not trying to time the market, which is, at best, an inconsistent strategy, and often, a counterproductive one. Instead, they should focus on the crucial goals and strategies that they can control – like saving more!
Rebalance Your Portfolio
Over a time period of 6 to 12 months, your asset allocation will invariably get out of balance. Some sectors will outperform; others will underperform. That doesn’t necessarily mean the underperformers should be eliminated. In fact, the cyclical nature of markets and the “law of averages” dictate that you should rebalance your portfolio.
As an example, if an asset is targeted at 12% of your portfolio and is now 10%, or perhaps 14%, you should either buy more or sell some to bring it back to your 12% target. This strategy ensures that you are “selling high and buying low,” at least on a relative basis. It won’t work in every market cycle, but it works over the long term. This process also eliminates the emotion and misguided guesswork of trying to time the market.
This principle has been tested over the past few years, but it is still a crucial step. Diversifying an investor’s allocation across the core asset classes and avoiding concentrated holdings will help limit risk. We’ve also learned that no investment should ever be considered “bullet-proof.”
The Economy is Not the Market
Despite lots of bad news still being reported about the economy, you must realize that investment values often move well in advance of any economic turnarounds. 2009 was a perfect example of this recurring phenomenon. So don’t let economic concerns derail your long-term disciplined savings and investing plans.
Save for Retirement
Save as much as you can, as soon as you can, and keep your costs as low as you can. After all, these three factors, along with your rate of return, are the only four factors that determine the value of your retirement nest-egg. But it’s still perplexing that most investors focus on investment returns when it’s the first three that they can actually control.
Live on Your Portfolio Income!
This gives investors, particularly retirees, the “staying power” to not have to sell assets at low prices or dip into principal to fund their retirement income.
We believe that if you follow these basic investing principles, you will go a long way toward ensuring your financial independence and security.