Asset Allocation: The Forgotten Approach to Investing
In my last segment, we discussed the common mistakes investors make when trying to “find the right time” to get into the stock market. This time I want to highlight another frequently overlooked, but critical, error.
Too often investors focus on choosing the best fund, picking the right stock, or focusing on the hottest sector. However, while they drive themselves crazy trying to predict all the right moves, they fail to recognize that it is really the degree to which they are exposed to specific asset classes and sectors that has the greatest baring on their portfolio’s overall performance. In other words, the allocation of your investment portfolio should be the primary focus of your investment strategy.
Is the market is unpredictable? Yes. However, remember that history has shown it moves cyclically. With that in mind, we recognize the best time to invest to be when the market is at its lowest. The right time to sell an investment is when it is at its peak. Sounds easy enough, right? Not so much.
Here’s more practical approach to that concept. Use an asset allocation. A proper asset allocation considers 2 elements: risk-profile and time frame.
Your risk-profile can be defined as your tolerance to market volatility. In layman terms, how comfortable are you with wild market swings on a monthly, quarterly, or annual basis? You really have to ask yourself these questions. If you aren’t certain, you don’t have to think too far back. How did you, or would you have felt, going through the emotional roll coaster ride as you experienced the turmoil we witnessed in the market place over the last few years?
Think about it like this: Are you the type of person that enjoys the biggest roller coaster in the theme park? It provides a lot of thrills. But there are many unsettling highs, and lows. Or are you the type that enjoys a calm and subtle kiddie roller coaster? There aren’t too many unexpected twists, turns, or drastic moves. Or do you enjoy something in that fall in-between?
Secondly, your time frame should determine the degree to which you should hold more historically volatile assets classes within your asset allocation. As a general rule of thumb, the longer your time frame, the more you can reasonably hold equity-based investments. Again, the markets are cyclical. So, if you give an investment TIME, it will recover from any low. Even recent market history has proven this to be true.
It’s probably clear that my philosophy is to stick to an appropriate allocation and re-balance. However, this is NOT the only philosophy or approach there is. I also want to make clear the primary basis for following an allocation and re-balancing is not solely to maximize returns. In fact, it is equally, if not more so, focused on mitigating market risk and volatility. If you can develop a model that is appropriate for you and that achieves this, follow it. If you do not have the time, energy, resource, or even interest in keeping up with this, I highly recommend using an advisor. Everyone is different. But always make the decision you feel is right for you, and one you feel best positions you for success.
