Principles of Long-Term Investing
This is Part 2 of the eight principles of long-term investing, as we continue to look at important principles that you may find useful in helping you make investment decisions.
4) Be Flexible And Diversified. Diversification is a powerful tool to reduce certain types of risk in your portfolio. Make sure that your portfolio contains a variety of quality investment types, including stocks, bonds, cash and alternative investments if your risk profile and investment goals support them. You can further diversify by industry, size of companies, country, sector and other factors.
This helps spread the risk among a wide variety of investments. Much of the market volatility of the last few years has been driven by economic events, natural disasters and government activities that are outside any investor’s control. While we can’t diversify away all forms of risk, a flexible strategy can help you find and take advantage of investment opportunities in many market conditions.
5) Buy Value, Not Future Economic Outlook. Don’t follow market trends. Wise investors focus on value when evaluating investment options. Too many investors focus on buying market trends and economic outlook, not realizing that trends can be deceiving and that markets often perform very differently from the economy. Focus on buying quality investments with good fundamentals. This is not to say that economic outlook is unimportant. Over the long term, market movements often foreshadow economic trends as investors attempt to “price in” how they expect the economy to affect stock prices. A smart investor keeps an eye on the economy and factors economic outlook into investment decisions, but ultimately seeks out high-quality individual investments.
6) Take The Proper Amount Of Risk. Experience and research has shown that investors do best when they take on the right amount of risk for their goals and tolerance. Too many investors focus strictly on generating returns while ignoring the importance of managing risk properly. Too much risk can leave your nest egg vulnerable to market swings with too little time to recover before you must start withdrawing money and locking in the losses. Too little risk in your portfolio will reduce your potential for capital appreciation and allow inflation to eat away at the long-term value of your investments.
The challenge is in determining how much risk is right for you and your portfolio. No one wants to see their portfolio lose money at any point, but it’s important to understand that generally, one must take on more risk in order to achieve higher long-term returns. Be honest about your ability to withstand short-term swings in value and take investment losses in the pursuit of returns. Another essential question that you must answer is how much risk you need to take on in order to meet your investment goals. The right risk allocation for a portfolio will depend on a number of factors: expectations for return, investment objectives, time horizon, liquidity, goals, net worth and appetite for risk. For more information, see a financial professional and visit artofthinkingsmart.com.