2. Let Time Work for You
When instructing his protegé Warren Buffett, author Benjamin Graham said, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” The numbers reflect his view – in the period between 1950 and 2010, the average return of the S&P 500 during a single year was 8.4%, which included a year with a great return of 53.4% and a stomach-wrenching loss of 44.8%.
In the short-term, equities are exceptionally volatile, reflecting the emotions of buyers and sellers. Over time, logic and actual financial result replaces emotions and returns even out (become less volatile). For example, since 1900, there have only been five 10-year periods that the market has produced a negative return. According to a study by Crestmont Research, the average return for the whole period (including the negative decades) for a 10-year period has been 10%.
The lessons to be learned from this history are as follows:
- Stay Invested. Pursue your investment strategy in up and down markets. There has been more money lost trying to call market direction than saved due to the emotions involved. If your goal is long-term capital appreciation, recognize that there will be times when market values are down.
- Dollar-Cost Average Your Purchases. Do not try to call the market’s direction – investing a periodic fixed sum will buy more shares when they are cheap and less shares when they are expensive.
- Diversify Your Investments. Individual companies are affected by the economy in different ways. Spreading your risk avoids a catastrophic loss in a single investment.
3. Focus on Asset Allocation
While the claim that asset allocation is the primary determinant in portfolio performance has been challenged by recent studies, it remains important, accounting for as much as 33% to 75% of the variance in returns. It is the single greatest factor for a long-term portfolio without active management (a typical self-managed retirement fund) – not individual investments, nor market timing. Many financial advisors recommend that the age of the account owner/beneficiary be considered when allocating assets; the younger one’s age, the greater proportion of assets should be invested in equity investments. For example, a 50-year-old might have a portfolio of 70% equity and 30% fixed income, while a 70-year-old would be better served with a portfolio equally split between equity and fixed income.
Re-balancing your portfolio annually is important, as values will constantly change. However, don’t become too aggressive trying to accommodate small changes. A study by T.Rowe Price showed a benefit of almost $20,000 over a 20-year period for those investors who balanced annually versus those who tried to adjust their holdings monthly.
And don’t forget the impact of management fees, commissions, and advisory fees on your total return when selecting your investments. While many fund managers promote the goal of “beating the market,” research shows that many fail to achieve that goal. Constant activity – buying and selling on a short-term basis – increases administrative costs. Consider the use of ETFs in your portfolio to minimize these costs with degrading profit potential. These costs can be greater than the effect of inflation on your ending values.