Successful long-term investing requires applying the principles of diversification and discipline. The concept of Strategic Asset Allocation allows us to apply these two principles to increase the probability of realizing competitive returns in the market when measured over a multiple-year period.
Developing our long-term strategic asset allocation requires us to establish – and maintain – fixed long-term percentage allocations among the various asset classes, e.g., stocks, bonds, cash, real estate and hard assets. This helps us to focus on long-term results instead of short-term results and trading tips.
Why is this important? Myopia. The more frequently we evaluate our portfolios, the more likely we are to see negative returns – which is really only fluctuation, not performance.
Inversely, the less frequently we evaluate our portfolios, the more likely we are to see the positive returns generated through long-term investing and a better measurement of performance. (When you look at your monthly brokerage statement, what are you really seeing is volatility, not performance.)
Another benefit of Strategic Asset Allocation is that allows us to manage the historic inevitability of bull and bear markets. Since WW II there have been 14 peak-to-peak stock market cycles. Trying to time the market is most often a fool’s game. Why? Because during a bear market, stocks are actually advancing about 35 percent of the time. So it’s often difficult to know that a bear market is occurring until after the fact.
So what’s the solution? Hold a diversified portfolio. By combining in a portfolio securities whose returns are unlikely to move in the same direction – or at the same rate – at the same time. These securities might include the stocks of different industries or sectors, foreign securities as well as other asset classes such as bonds and cash.
By combining securities that move differently we increase the probability that at least one element of their portfolio will capture a positive trend even while another element may be declining. Why is this important? Because this approach enhances our likelihood of gains but with less volatility than a more narrowly focused portfolio. Broad diversification can also ensure that a portfolio will capture the market’s well established tendency to rise over time.
Adding the discipline of “rebalancing”, i.e., re-setting our asset allocation to their original percentages, more often than not allows us to buy-in closer to lows, and sell-out closer to highs, than otherwise. This discipline also allows us to actually make market volatility work in our favor. It’s how smart, long-term money invests.
This material is not intended to replace the advice of a qualified tax adviser, attorney, accountant and/or insurance adviser. You should consult with the appropriate professional before you make any financial commitment regarding the issues related to your situation. These projections and examples are hypothetical and do not reflect actual investment results and are not a guarantee of future results.
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