Focus on what is important
Here’s a simple, four question quiz that will give a pretty good prediction of how well your family will do on your lifetime investment returns. Just answer yes or no to the following:
- Are you an owner as well as a loaner? (Do you hold shares as well as bonds?)
- Is your portfolio truly diversified?
- Do you try to time the market by selling when stock prices are high and buying when they are low?
- Are you prone to panic during periods of market volatility?
Hopefully, you answered ‘yes’ to the first two questions, and ‘no’ to the last two. If so, your 2 + 2 should add up to 90, as studies1 show paying attention to these four things determines 90% of the variability in your investment outcomes.[DF1]
Why you need stocks as well as bonds in your portfolio
Stocks give you ownership in some of the world’s greatest companies; when you hold bonds, you are lending your money to governments and corporations. Stocks and bonds offer different levels of potential return and market risk. As a holder of stocks, you assume the risks of business ownership; however, when the companies you own flourish, you participate in their success. When you lend money, you get your principal back—assuming you hold the bond to maturity—along with interest. Bonds may not shield you from the risk of inflation.
To determine how much ownership risk you should assume, you need to consider your financial situation in terms of the number of income-producing years you have ahead of you, as well as the gap between what you have now and how much money you will need in the future. Your portfolio might be based on a conservative model (say, with 40%[DF2] stocks), balanced (60% stocks), or growth (80% stocks).
If your current portfolio is not constructed to offer sufficient growth potential to reach your financial goals, you might conclude your greatest risk is running out of money in your retirement.
Are you truly diversified?
In constructing your portfolio, your goal is to balance investments which offer the highest potential for growth—and, since risk and return are related, also the highest risk—with those that carry less risk but also less growth potential. You need to be truly diversified—by country, industry, asset class, and types of securities. Making sure that you hold investments that are very different from each other will help tame volatility in your portfolio: if the returns on the investments in one part of your portfolio are falling, there is a greater chance that those in another part are rising.
Trying to sell high and buy low
Markets tend to recover from declines very rapidly, but there is no way of predicting when these recoveries will occur. If you are tempted to pull your money out of the market when stock prices are plummeting and get back in again when they start to rise, here’s an eye-opener. If you were out of the market for just a few days over the 20-year period from January 1, 1993 to December 31, 2012, the difference in your returns compared to someone who stayed in for the entire time is startling. Let’s say you invested $10,000 at the start of this period:
If you stayed in the whole time, you would have accumulated $51,404 (8.53% return)
If you missed the 5 best days in 20 years: $34,113 (6.33%)
Missing the 10 best days: $25,709 (4.83%)
Missing the 20 best days: $16, 029 (2.39%)
Missing the 30 best days: $10,599 or a 0.29% return on your investment
(Source: Standard and Poor’s. Stocks are represented by Standard & Poor's Composite Index of 500 Stocks)
Unless your crystal ball is in perfect working order, don’t try to time the market.
Don’t panic when the market resembles a roller-coaster
Although past performance doesn’t guarantee future results, historically stocks have steadily risen in value over the long term. As the chart below shows, there have only been 5 years of negative returns on the S&P 500 in the past 25 years. If you are a short-term investor, you might have been caught in one of the downturns; however, long-term investors would have benefitted from the 25-year average return of 11.34%.
Annualized Total Return S&P 500, 1998-2012
Source: Standard and Poor’s. Stocks are represented by Standard & Poor's Composite Index of 500 Stocks, an unmanaged index generally considered representative of the U.S. stock market.
Think long-term and prosper
Keeping your focus on what is important greatly increases your chances of reaching your long-term financial goals.
Gary P. Brinson et al.
This article was first published in the July 2013 issue of Sask Business, authored by Daryn Form.
Daryn Form is a Senior Financial Advisor with Assante Capital Management Ltd. providing wealth management services to principals of family-owned and privately held companies. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and is registered with the Investment Industry Regulatory Organization of Canada. The information mentioned in this article is for general information only. Please contact him to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Capital Management Ltd. Rates are not guaranteed and are subject to change at any time without notice.