Watching the stock market fall and your asset balances decline is a stark reminder of the emotional ride investing and risk-taking provides. Typical behavior is to celebrate during the good times and be driven crazy by the selloffs.
As we help our clients survive market sell-offs and build durable portfolios, the following three investment disciplines help keep us grounded.
1. Invest for the long-term and avoid short-term reactions
Taking action in response to market sell-offs and declining account balances is market timing and when you sell you are locking in your losses. Getting back into the market is not easy because you can get consumed by the emotion or you lose track/don’t have time. Good and bad days tend to cluster together so the tendency will be to miss the rebound. The bounce off the bottom can be sudden and before you know it a major portion of a rebound has occurred. In the end, you have sold low and the reinvestment likely will be at higher prices.
2. Diversify your portfolio to increase stability
Diversification gives your portfolio stability by balancing exposure to different sectors, styles, types of assets and even different economies. It would be great to own just the highest returning sector or stock but that strategy is difficult to do and usually leads to subpar returns over time. Smart diversification is based on projected returns and volatilities blended together to increase stability and the odds of a favorable outcome. Our approach builds a balanced portfolio that aligns with long-term goals and small tactical rebalancing adjustments are made as needed. It’s common to hear someone say they avoided the market downturn, which makes me wonder, with what percent of their assets and what has been their return over the last five years? Investing is a marathon, not a sprint.
3. Avoid letting one goal drive your strategy
College, retirement and your various spending needs have distinct time horizons so build portfolios that match the specific time horizon of each goal. A common mistake is to underinvest assets and thereby run the risk that inflation will reduce the value of your portfolio. Equally bad is having to realize a loss in a down market to satisfy a known cash need. Emergency and short-term funds should take little to no price risk but they should earn an appropriate yield. Long-term assets should target a higher return, earning well above the rate of inflation to improve the real rate of return of the portfolio.
Large market drops can rattle any investor, so it’s important to focus on your long-term goals and stick with them in up and down markets. Investing should be calculated and targeted. Put a laser focus on long-term results and outcomes.
To see our current thoughts on the economy and portfolio management please refer to our Quarterly Letter.
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John Kirby is a Principal and Co-founder of Laurentide Advisory