Some investors were given a shocking lesson in 2008 when stocks took a nosedive after years of double-digit gains. Many forgot that the market can move in two directions and subsequently saw their portfolios lose as much as half their value. Yet investors who remembered that important lesson saw their portfolios recover—and often exceed—their pre-2008 levels as stocks posted double-digit returns and established new nominal highs in the years that followed.1
So what now? Even the greatest economists can’t be certain which way the market is headed next. But that doesn’t mean you need to invest blindly. Now, and any time, is a good time to reflect on some of the timeless lessons learned over decades of market ups and downs. By practicing the following eight tried-and-true investment principles, you may be able to help insulate your portfolio against short-term market volatility and gain an edge in an uncertain market.
Understand the Difference Between Saving and Investing. In some respects, saving and investing are two different sides of the same coin. Both involve putting money away today to be used for future needs down the road. However, the way you view savings vs. investing should be very different.
Saving is appropriate when your primary goal is to make sure your money is readily available when you need it. As a result, it involves putting your money in a safe place where your principal is protected. Examples of savings are the emergency fund you set up for unexpected expenses. This bucket should contain six months’ worth of living expenses in highly liquid, cash-like instruments, such as a money market or high-interest savings account.
In contrast, investing means setting aside money for future use and letting it grow—a process that exposes your money to some measure of market risk. The more risk you assume, the more potential you have to earn a higher return—and the greater the potential for loss.
Protect Your Risk-Based Needs. Most people look at the value of their assets—their home, retirement savings, other investments, etc.—and then subtract their debt to calculate their net worth. One asset many fail to consider is what experts refer to as your human capital—in other words, your ability to work and earn a living.
While your human capital isn’t cash in hand, the value of your expected future earnings needs to be protected and managed just like other assets in your portfolio. That’s because if there is a sudden loss in your ability to generate income, due to either disability or death, you and your family could be exposed to the significant risk of financial hardship.
Disability insurance can protect your income in the event that you cannot draw on your human capital due to illness or injury. Permanent life insurance from a top-rated company does double duty by protecting your income for your dependents in the event of your death and by providing the potential to contribute financial capital through the cash value of the policy.
Diversify, Utilize a Strategic Asset Allocation Strategy and Re-balance. One of the most important insights into market performance is that you can rarely predict the winners and losers in any given market. For this reason, the age-old adage that you shouldn’t put all your eggs in one basket continues to hold true regardless of market conditions.
In a strategic, diversified portfolio where your money is spread among asset classes according to your risk tolerance, goals and time frame, some assets will experience greater swings in value than others, but investment returns should balance over time. The key is to appropriately diversify between assets with greater risk or less risk while protecting against holding a concentrated risk in any one particular asset class.
Once you’ve established a diversified portfolio through asset allocation, it’s important to maintain that diversification in order to help ensure you can meet your long-term financial goals. One way to do this is by regularly selling assets that have appreciated beyond your asset allocation strategy and purchasing those asset classes that have become underweighted through a process called portfolio rebalancing.
If It Seems Too Good to Be True, It Probably Is. The legendary basketball coach Al McGuire was on point when he said, “Anyone who offers to double your money, walk away. If he offers to make you 20 percent, hear him out.”
Very simply, there are no free lunches, especially when it comes to investing. Don’t reach for yield. Don’t be seduced by the promises of managers to deliver index-beating performance. Instead, ask yourself “What am I investing in and how does it work?” If you don’t know, find out. Then ask yourself, “What’s the worst possible outcome that could occur from holding this instrument?” Make sure that you can live with the answer before you invest.
Avoid Trying to Time the Market. Often investors buy and sell at the wrong times, letting their emotions guide their decisions. Don’t fall into this trap. Sitting on the sidelines waiting for the “right time” to invest involves two tough decisions that even investment experts have trouble making consistently: when to get out of the market and when to jump back in.
Upward moves in the market tend to happen in short bursts of a few days. To make sure you don’t miss out on those powerful upswings, you have to stay invested. The long-term gains you may realize from being invested during a recovery period may lead to portfolio value in the long term.
Balance Optimism with Skepticism. It’s as easy to get caught up in the euphoria of a soaring market as it is to shrink in worry when the markets head south. Ignore the hype and adopt an investment outlook that is rational—one that tempers optimism with a healthy dose of skepticism. Listen to your inner skeptic that the markets go in cycles and can change course at any moment. Balance this perspective with your inner optimist by having confidence that the hierarchy of returns—equities over bonds, bonds over cash—still holds true in the long run. Rather than jumping into a hot market, do your due diligence first. If an investment could lose money, understand where the risk comes.
Be Humble. Investing is, by nature, a humbling experience. Even professionals sometimes find themselves on the wrong side of a decision. However, rather than compounding a mistake by waiting for the market to correct it for them (the classic “I’ll just hold on until the price bounces back”), professionals understand that it’s often better to close the position and move on to a better idea. So should you. Your success as an investor is dependent on your ability to learn from both your positive and your negative experiences and to make investment decisions based on sound, sensible fundamental choices.
Don’t Tell Yourself, “It’s Different This Time.” It Never Is. Many pundits, respected academics, strategists and financial advisors go to great lengths to show that the markets will be different this time around. But that doesn’t negate the facts that the core market fundamentals are still in place, and the basic tenets of capitalism still apply. Take note of history and avoid the market forecasting game, no matter how sound you believe your process to be. Having a long-term investment strategy, executed with a repeatable process, is essential to taking the emotion, and your own ego, out of your investment actions.
Bottom line: Having a clear investment plan, founded on time-tested investment strategies—and sticking with it—is one of the best ways to build financial security for the future.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. No investment strategy can guarantee a profit or protect against a loss.
I am not a financial adviser and this is not financial advice, this is simply the strategies that were presented to me by my Insurance adviser at Northwestern Mutual