I could sit here tonight and write about what the markets will do tomorrow. There’s a good chance that what I write will be correct. And if I was right, would you attribute that to brilliance or luck?
We would all like to be able to predict, or have someone predict for us, what the markets will do tomorrow. If anyone was truly capable of this, they could make billions from $1. Though we’ve yet to see this happen, we all want to believe that it is in fact possible.
Nobody can tell you whether the markets will go up 20% or down 20% in the next major move. What we do know is that historically the market has gone up in the long-term, despite short-term loses. The Dow Jones Industrial Average has in fact doubled eight times since 1900. If you are investing for the long-term, for your lifetime, doesn’t it make sense to invest for the next 100% swing rather than the next 20% swing?
So what does it mean to invest for the next 100% swing? It means you should consider having the following:
- 6 months worth of income in emergency funds.
With emergency funds in place, as little growth as they may receive today, it allows us to take more risk and maximize tax advantage in investments. It helps us to minimize fear and make sure that we do not have to sell in a down market.
- 5 years of what we need to spend in conservative investments.
Once we retire, we need to have enough conservative investments to withdraw from to satisfy our income needs for five years when the market goes down 15% or more. Historically, the market has corrected in approximately 5 years and we can rebalance and reset our conservative assets. In retirement, the biggest risk to our long-term financial stability is to spend down in a bear market.
- An appropriate risk tolerance for what we can tolerate in bad times.
You need to understand what your true risk tolerance is at the gut level and make sure your portfolio is in alignment.
- An understanding of the probabilities of returns for our risk tolerance.
You not only need to know your risk tolerance, but also what to expect regarding fairly random future returns. It’s the randomness and variability of annual returns, which when we are not prepared, can lead to emotional and very likely disastrous, investment decisions.
- A properly allocated portfolio.
91.5% of a portfolio’s return is determined by allocation of asset classes.* Let’s maximize this!
- A systematic and unemotional thought process.
A plan enables us to stay on track when markets look bad, and everybody is telling us the sky is falling and that it’s different this time. A plan is what keeps us systematic and unemotional, even when those around us are not.
- A portfolio void of style drift, overlap and active management.
Our portfolios need to be managed systematically and unemotionally as well as our own thought processes. We need to be systematic with our investing and rebalance regularly in our portfolios.
With the above things in place, you will not feel the need to find the one who can predict the future, or the one who can outsmart the market. You will become an investor ready for the next 100% swing!
* Source: Study of determinants of portfolio performance published by Brinson, Hood and Beebower in the Financial Analysts’ Journal. Jan/Feb 1995
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. No strategy assures success or can protect against loss. Investing involves risk including loss of principal.