Investing principles to provide you comfort during exuberant markets
When markets reach new record highs, you wonder, “Is this a bubble?” When markets head the other way, you wonder, “Is this a crash?”
Your biggest question: How do you keep your head during what is currently the longest economic expansion on record (well over 10 years)?
On the one hand, the media is touting the S&P 500’s cumulative return of almost 250% over the past 10 years. And while the U.S. equity markets over the previous decade were certainly remarkable, it was also the only decade on record that did not register a recession and just the second decade that did not experience a bear market.
Makes you wonder if we’re overdue and the guessing is enough to whipsaw your neck and make your retirement accounts ache.
There’s an effective medium, though, between doing nothing and panicky trading. These guidelines can keep you level-headed even while the markets twist and turn and record new record highs.
An Investment Policy Statement
Revisit or develop your investment policy statement. An IPS describes procedures, your investment philosophy and style, guidelines and constraints for you and your advisor to manage your investments. An IPS serves as your guardrail so you don’t veer all over, chasing investments or changing your strategy as markets change.
To begin creating your IPS, write down your key investing goal and the year in which you hope to reach it. If this goal will take you years (such as funding your retirement or paying for a child’s college education), try to figure your own longevity – then add a few more years. Quantify how much your goal costs and remember to adjust the cost upward to reflect inflation’s likely future impact.
Next, set your asset allocation targets for investments. Your IPS needs to fix a range for your asset allocation rather than a static figure for each class. This increases your options for making investment decisions if the markets rise or dip just a little.
Finally, document specifically the market conditions that will spur you to make investment decisions. That way you’ll know what to do and exactly when – not just when your emotions move you.
Use Mutual Funds
These are diversified buckets of holdings that follow general market rises and falls. The odds of one or a few companies dropping to zero at the same time are slim. The odds of all the companies going to zero at the same time in a mutual fund are almost nonexistent.
You may reduce your worries about losing your money – although the value of a mutual fund still goes up and down – as well as grow comfortable with changing values and learn how to rein in your exposure to those changes.
Investing in more than one mutual fund is also a basic part of protecting your portfolio with diversification and asset allocation (two different tactics).
Make a Plan
Forget about predicting the future. Correctly guessing one event is lucky. Nailing 10 events – that’s prediction. Nobody accomplishes that regarding the markets.
Approach investing with no predictions: Being wrong can carry huge costs.
- Develop a prudent plan. Include structured processes with decision rules to guide you and that already consider markets always going up and down. The degree of ups and downs you weather depends largely on your tolerance and capacity for risk.
- Customize your portfolio. Base it on the principles above and tailor it to you and your situation. Don’t invest based on chit-chat around the water cooler, structuring financial moves based on someone else’s situation and needs. To do so sends you chasing investments that are merely hot and not necessarily what’s prudent for you.
Combining and using these principles can provide you some comfort during any market.