When it comes to long term investing and financial planning, there are some things we know for sure. We know that the stock market is a good bet over time. We know that there will be periods of time when the stock market doesn’t do well. We also know that the ups and downs of the stock market are impossible to predict.
We don’t know precisely when these good and bad times will occur, or by how much. Part of the role of the professional financial advisor is to help you devise strategies to weather the inherent volatility of the market.
No one can truly eliminate risk. We can’t guarantee that you will not lose money. In fact, there will be times when you might lose a lot of money. But the purpose of diversifying assets is to be able to weather the inevitable volatility so that, long term, you reach your financial goals.
What is diversification?
Diversification is about avoiding extremes. It’s using a strategy to balance risk.
What is asset allocation?
In your financial portfolio, you likely have a mix of different types of investments, such as stocks, bonds, and cash. When you begin working with a financial advisor, we’ll help devise a plan to balance the different types of investments strategically to best suit your time horizon and long-term goals.
This is not a set-it-and-forget-it strategy. To properly manage a portfolio, it’s important to revisit the asset allocation – the mix of different types of investments – periodically, generally once a year.
How do you determine which asset allocation strategy is right for you?
We use a multi-step process to determine the best asset allocation strategy for each client.
- First, we identify objectives. Every time we review your portfolio, we go over your goals to determine if any have changed.
- Then, we review your time horizon. How long do you want to keep your money invested?
- The next step is to select investments. We will generally recommend a mix of domestic stocks, international stocks, bonds, cash, and possibly REITs (real estate investment trusts), but the mix is highly tailored to each individual.
- We will recommend a schedule for review of your portfolio, mostly likely once a year, but that can vary based on each client’s needs, goals, and time horizon.
- Finally, we will rebalance your portfolio, if needed. Nothing about long-term investing is static. It’s important to continually evaluate and adjust your investments to get the best possible long-term result.
What types of products make up a portfolio?
To diversity your portfolio, it helps to have a clear understanding of the types of products that will go in that portfolio.
· Domestic stocks: These are among the most aggressive types of investments, with the highest volatility. They also have the highest potential for return.
· Bonds: These are less volatile than stocks, and are good for providing interest income. Bonds generally have a lower rate of return than stocks, so it’s good to think of them as a cushion or a foundation for your portfolio overall.
· Short-term investments: These include certificates of deposit (CDs) or money market funds. These are safe, stable places to put your money, and serve as a nice counterpart to stocks. Particularly good for preserving principal, short-term investments have a return that is a little better than a savings account.
· International stocks: Because international companies can perform differently than U.S. companies given the different economies at play, including international stocks in your portfolio can help with diversification.
· REITs: Real estate investment funds can also be a nice balanced component to an investment portfolio. Investing in a real estate investment trust, known as a REIT, is a way to invest in real estate without going through the process of buying or selling individual properties yourself.
Why reallocate your investments?
We all age, and our goals change. You may start with 70% of your investments aggressively invested in domestic stocks, with perhaps 20% in bonds and 10% in cash. But, ten years from now, you’ll be that much closer to retirement, so it may not be wise to keep so much of your portfolio invested so aggressively. That’s where your financial advisor may recommend adjusting those percentages or including REITs or international stocks to your portfolio.
Looking forward
The economy changes, your personal situation changes, your goals change, tax laws change, retirement laws change, market forces and government policies change. Your investment portfolio needs to change as well.
Over time, the stock market is a great bet. That doesn’t mean it’s bulletproof. Fluctuations are normal. Rebalancing your portfolio is how you best manage that change for the long-term.
*Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal.