Stock (and bond) market volatility has been up quite a bit recently. Why is it happening and what does it mean to me and my family’s financial well-being? The price of oil is down along with the value of the Russian Ruble – is this good or bad for my portfolio? Credit spreads have widened (and narrowed again recently) – am I in the high yield market and if so, what should I do? Yes, all these questions (and many more) are important to consider when determining investment strategy, but understanding these very important concepts below will help you to get the results you want and need from your portfolio.
It can be tempting to try and anticipate the ups and downs of the market. It seems that the media spends much of their time discussing what market experts, economists, and traders are predicting for the next day, week or month. Some of this information can be valuable if you are a TRADER – trying to anticipate these short term changes and make money by trading on these estimates. By contrast, most of us are INVESTORS. We are in the stock market to beat inflation and earn a reasonable return. Your advisor should help you to determine what return you should have as a goal, based on your needs and time horizon. The longer the horizon, the less your portfolio feels the impact of volatility. If you need your funds to buy a house in six months, then it will really only be luck if your portfolio is up when you need the funds. And investing should have nothing to do with luck.
Studies show, and results mostly bear this out – over 90% of your portfolio return is based on what asset allocation you and your advisor choose, based on your time horizon, and what your risk tolerance is. An advisor can recommend a higher risk portfolio, but if you cannot be comfortable with market swings, you are most likely to sell some (or all) of your portfolio at the exact wrong time. Many investors trying to time the market actually get out of the market AFTER it has suffered most of the downdraft. Even if you do get out at the right time, you then must choose when to get back in to the market. So, you need to make TWO correct decisions regarding market timing, to be a successful investor.
This is not to say we are advocating a “buy and hold” strategy. Effective asset allocation typically involves adjusting your portfolio regularly, based on market volatility. As one portion of your portfolio increases in value, and another portion decreases, proper asset allocation (based on your objectives and risk tolerance) would dictate selling some of what is up and buying some of what is down. By rebalancing back to your indicated asset allocation, you are systematically buying low and selling high. Your advisor may also make some recommendations regarding tactical changes to your portfolio, based on economic and market forecasts. These changes, though, should not be so significant that they result in making big bets to achieve higher returns, or compromise the appropriate asset allocation for your objectives.