Knee-jerk reactions to market fluctuations can lead to buying high and selling low, making it difficult to stay on track and achieve long-term financial goals. Remaining invested in a diversified portfolio for the long-term can help avoid the pitfalls of emotional investing.
The market goes up. The market goes down. Volatility, sometimes extreme, is a fact of life. Successful investors understand this and know how to prepare and act accordingly.
Here is what many of them do:
Knee-jerk reactions to market fl uctuations can lead to buying high and selling low, making it diffi cult to stay on track and achieve long-term financial goals.
A well-diversified portfolio may help smooth out the market’s inevitable highs and lows and help investors pursue their long-term goals.
Market highs and lows have historically evened out over the long term. Adhering to a lengthy time horizon may not always be easy, especially in a downturn, but it can be a valuable discipline.
Emotional reactions to market fluctuations—especially fear, hope, and greed— can make it diffi cult for investors to stay focused and make rational decisions. Not surprisingly, the graphic depiction of emotional investing resembles a roller coaster.
Allowing emotions to drive short-term investment decisions may lead to selling low and buying high, classic mistakes that can make it diffi cult to achieve long-term fi nancial goals.
One way to avoid this all-too-human behavior is to not fall prey to media coverage, especially during a downturn. The media often makes a big deal out of market volatility, and while it’s fi ne to stay abreast of this news, successful investors don’t overreact.
Another way to avoid emotional investing is by working with an investment advisor—someone who understands an investor’s tolerance for risk and longterm financial goals.
An accomplished advisor knows the need for dispassionate analysis in the face of market turbulence and can help investors create a portfolio designed to weather any condition. Two signature traits of such a portfolio are asset allocation and diversification.
Sometimes confused, both are important because they can help minimize dramatic ups and downs in the market. Together, they form a stable foundation for a long-term investment plan.
Asset allocation entails spreading investments among different asset classes such as bonds, cash, and stocks. Because different asset classes perform differently in various economic environments, asset allocation may help balance the
varying risk and return cycles of different market segments.
Diversification entails allocating portfolio dollars among different investments within each asset class. For example, investments in the equity asset class might include stocks that are U.S. large cap, international and emerging markets. Over time, diversication may help maximize return by reducing exposure to market ups and downs.
Investors with a lengthy time horizon are advised to have a durable portfolio that is positioned for the future. As this chart shows, the longer investments are held, the greater the likelihood that the range of returns will tighten and the potential for negative returns will decrease.
Source: FactSet. Past performance is no guarantee of future results. Average returns from January 1, 1997 through December 31, 2016. Returns for periods less than one year are not annualized. See bottom of page for a list of representative indices. The indices are unmanaged, are not available for investment and do not incur expenses.
Keep in mind even the most brilliantly conceived long-term portfolio may not succeed if the investor falls prey to emotional investing. Another way to avoid it is through the discipline of dollar-cost averaging.
Designed for investors with long-term objectives, this approach requires investing a fi xed-dollar amount at regular intervals over all cycles of the market, regardless of the price. More shares are purchased when prices are low and fewer shares when prices are high.
Market volatility can test the emotional fortitude of any investor. What’s required is the discipline to stay the course, knowing your portfolio was designed to weather turbulent times and that reacting emotionally may be counterproductive. Discipline is essential to helping investors achieve their long-term goals.
All investments are subject to risk including possible loss of principal
Cash—ICE BofAML U.S. Treasury Bill Index (0-3M) (USD Unhedged): The index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.
U.S. Bonds (U.S. Agg)—The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
Tax-Exempt U.S. Bonds (Munis)—The Bloomberg Barclays U.S. Municipal Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed tax exempt bond market. The index includes state and local general obligation, revenue, insured, and pre-refunded bonds.
Large Cap U.S. Stocks (U.S. LC)—The S&P 500 Index is a capitalization-weighted index of 500 stocks.
Small Cap U.S. Stocks (U.S. SC)—Russell 2000® Index measures the performance of the 2,000 largest companies in the Russell 3000® Index, which represents approximately 90% of the total market capitalization of the Russell 3000® Index.
Commodities (Comm)—Bloomberg Commodity Index is composed of futures contracts on physical commodities. The Index is calculated on an excess return basis and reflects commodity futures price movements.
International Stocks (Intl Stock)—The MSCI World ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets countries—excluding the United States. With 1,021 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
Emerging Markets (EM)—The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The Index consisted of the following 23 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. Please go to msci.com for most current list of countries represented by the index.
Real Estate (REITs)—The Dow Jones U.S. Select REIT Index intends to measure the performance of publicly traded REITs and REIT-like securities. The index is a subset of the Dow Jones U.S. Select Real Estate Securities Index (RESI), which represents equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded in the U.S.
Effective October 20, 2017, the BofA Merrill Lynch indices were renamed ICE BofAML indices.
Charts and graphs included in this presentation are not meant as investment tools or to assist with investment decisions. Information has been obtained from sources believed to be reliable, but its accuracy, completeness, and interpretation are not guaranteed. The foregoing discussion is general in nature, is intended for informational purposes only and is not intended to provide specific advice or recommendations for any individual or organization. Because the facts and circumstances surrounding each situation differ, you should consult your attorney, tax advisor or other professional advisor for advice on your particular situation.
Imagine a simple scenario. You have $1 million 100% invested in the S&P 500 Index. You retire and start to withdraw $100,000 annually, increasing that amount in line with inflation, while the rest of your money stays invested in the S&P. How long does your $1 million last?Read Full Perspective
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