The past few years have been troubling for investors. We saw essentially two bear markets and two bull markets. These turbulent markets have caused many investors to overlook or forget the fundamentals of solid long-term investment success. Just as baseball players take time each spring to review the fundamentals of good baseball, it is important that investors do a similar review of the fundamentals.
One of the main ones is asset allocation. Every investor should have goals, an asset allocation that is consistent with their goals and their risk and return requirements, and review it regularly. If it has “drifted” by more than 5 percentage points, investors should consider restoring it. For example, if their desired allocation was the classic 60% stocks and 40% bonds and is now 55% stocks and 45% bonds, they should consider selling some bonds and buying some stocks to get them back to their desired allocation. Changes in risk and return are highly correlated with changes in asset allocation.
Another major one is securities risk. Anything but CDs, short-term US Treasuries or money market funds involves real risk. Investors should review their securities to make sure they understand what kind of risk they are taking and whether the expected incremental return they expect is large enough to compensate me for those risks. Risk may change over time with economic changes and individual security perspectives, and investors should be alert to these changes.
It is also fundamental for investors to understand their investment style: Are you an aggressive investor looking for maximum capital gains? Are you a conservative investor who wants to preserve your capital? Are you an income investor looking to maximize income? Your investments should match your style.
Ask fundamental questions
This leads to two main questions: What role does each particular investment play in my portfolio? How will it help me achieve my investment goals? A portfolio that is a mix of randomly selected securities without an overall strategy is unlikely to be effective in achieving an investor’s goals.
Another key question is: Do I understand my investment limitations? It is extremely important that an investor not invest in strategies or securities that they do not fully understand. Investing beyond one’s skills can result in damage to your financial health. For example, buying an individual “junk” bond when the investor does not have the ability to analyze the probability of default creates problems. Likewise, following an options investment strategy without understanding the details of how options work or how to decide their “fair” value is asking for trouble.
Another key question is: Do I have realistic expectations of the returns available from various types of investments based on their historical returns and future economic opportunities? This knowledge can prevent investors from making silly mistakes. For example, if someone advertises a stock as likely to return 50% per year and the investor knows that historically the stock has returned around 10% and the economy looks uncertain, then he should study this investment very carefully and possibly avoid losing money .
All data and projections are for illustrative purposes only and are not an inducement to buy or sell securities. Past results are not indicative of future results. If you have a financial issue you’d like to see discussed in this column, or have other comments or questions, you can contact Robert Stepleman c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at [email protected] . rr.com. It offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is affiliated with Dow Wealth Management, LLC.