Sometimes the best, most rigorously developed financial advice is so obvious, it’s become cliché. And yet, investors often end up abandoning this same advice when market turbulence is on the rise. Why the disconnect? Let’s take a look at five of the most familiar financial adages, and why they’re often much easier said than done.
- If you fail to plan, you plan to fail.
- No risk, no reward.
- Don’t put all your eggs in one basket.
- Buy low, sell high.
- Stay the course.
1. IF YOU FAIL TO PLAN, YOU PLAN TO FAIL.
Almost everyone would agree: It makes sense to plan how and why you want to invest before you actually do it. And yet, few investors come to us with robust plans already in place. That’s why deep, extensive and multilayered planning is one of the first things a fiduciary should do when welcoming a new client, including:
- A Discovery Meeting – To understand everything about you, including your goals and interests, your personal and professional relationships, your values and beliefs, how you’d prefer to work with an advisor … and anything else that may be on your mind.
- Comprehensive Financial Planning – To organize your existing assets and liabilities, define your near-, mid-, and long-range goals, and ensure your financial means align as effectively as possible with your most meaningful aspirations.
- An Investment Policy Statement (IPS) – To bring order to your investment universe. Your IPS is both your plan and your pledge to yourself on how your investments will be structured to best align with your greater goals. It describes your preferred asset allocations (such as your percentage of stocks vs. bonds), and is further shaped by your willingness, ability, and need to tolerate market risks in pursuit of desired returns.
- Integrated Wealth Management – To chart a course for aligning your range of wealth interests with your financial logistics: insurance, estate planning, tax planning, business succession, philanthropic intent and more.
As we’ll explore further, even solid planning doesn’t guarantee success. But we believe the only way we can accurately assess how you’re doing is if we’ve first identified what you’re trying to achieve, and how we expect to accomplish it.
2. NO RISK, NO REWARD.
In many respects, the relationship between risk and reward serves as the wellspring from which a steady stream of financial economic theory has flowed ever since. Simply put, exposing your portfolio to market risk is expected to generate higher returns over time. Reduce your exposure to market risk, and you also lower expected returns. There’s ample evidence that periodic market downturns ranging from “ripples” to “rapids” are part of the ride. Referencing a February 2018 report via Vanguard, from 1980–2017, the MSCI World Index recorded 11 market corrections of 10% or more, and 8 bear markets with at least 20% declines lasting at least 2 months. Such risks ultimately shape the stream that is expected to carry you to your desired destination. Consider them part of your journey.
3. DON’T PUT ALL YOUR EGGS IN ONE BASKET.
At the same time, “risk” is not a mythical unicorn. It’s real. If it rears up, it can trample your dreams. So, just because you might need to include riskier sources of expected returns in your portfolio, it does not mean you must give them free rein.
This is where diversification comes in. Diversification is nothing new. In 1990, Harry Markowitz was co-recipient of a Nobel prize for his work on what became known as Modern Portfolio Theory. Markowitz analyzed “how wealth can be optimally invested in assets which differ in regard to their expected return and risk, and thereby also how risks can be reduced.” In other words, according to Markowitz’s work, first published in 1952, investors should employ diversification to manage portfolio risks.
The details of how these risk/return “levers” work is beyond the scope of this article. But come what may, the desire and necessity to DIVERSIFY your portfolio remains as important as ever – not only between stocks and bonds, but across multiple, global sources of expected returns.
4. BUY LOW, SELL HIGH.
Of course, every investor hopes to sell their investments for more than they paid for them. Here are two best practices to help you succeed where so many fall short: time and rebalancing.
Time
By building a low-cost, broadly diversified portfolio, and letting it ride the waves of time, all evidence suggests you can expect to earn long-term returns that roughly reflect your built-in risk exposure. But “success” often takes a great deal more time than most investors allow for.
In the market, 10 years is not long. You must be prepared to remain true to your carefully structured portfolio for years if not decades, so we typically ensure that an appropriate portion is sheltered from market risks and is relatively accessible (liquid). The riskier portion can then be left to ebb, flow and expectedly grow over expanses of time, without the need to tap into it in the near-term. In short, time is only expected to be your friend if you give it room to run.
Portfolio Rebalancing
Another way to buy low and sell high is through disciplined portfolio rebalancing. As we create a new portfolio, we prescribe how much weight to allocate to each holding. Over time, these holdings tend to stray from their original allocations, until the portfolio is no longer invested according to plan. By periodically selling some of the holdings that have overshot their ideal allocation, and buying more of the ones that have become underrepresented, we can accomplish two goals: Returning the portfolio closer to its intended allocations, AND naturally buying low (recent underperformers) and selling high (recent outperformers).
5. STAY THE COURSE.
Planning and maintaining an investment portfolio are important. But even the best-laid plans will fail you, if you fail to follow them. Stay calm during difficult times, trust in your planning and stay the course!