It can be tempting to focus on investment results disproportionately in comparison to the rest of your finances. This is the “sexy” part of personal finance where we get to brag about the money we made in the Twitter IPO. However, I try to steer clients clear of this kind of thinking. Over the long run it doesn’t serve us well to chase returns. Instead think about these concepts:
Your portfolio is not your plan.
Too much emphasis on the performance of investments can be detrimental. It’s important to monitor your investments and rebalance your portfolio at least once a year. However, this should not be to the exclusion of other parts of your financial plan, such as savings rates, tax liability, risk exposure etc. A hole in one of those areas could negate all your investment efforts.
Create an investment strategy.
Having an investment strategy that you can stick to is far more important in the long term than high returns in the short term. A diversified portfolio can protect against all investments from tanking at once. It is important to take the volatility and risk of a portfolio into account as well as the upside potential. It is important to understand what you can stomach when the performance of your investments isn’t doing well.
What we can be almost sure of is that at some point the stock market will take a dive. However, that doesn’t mean we shouldn’t invest. According to this article titled Awaiting the Next Market Crash, since 1928 the stock market has fallen 20% in one day a few times a decade. However, if you stayed in the market you would have come out ahead. The article goes on to say that, “Understanding how common market crashes are is important. Why? Because during this 85-year period, the S&P 500 returned more than 9% per year, turning every $1 invested into more than $2,700 within a lifetime. Even after inflation, each dollar invested turned into more than $200.”
There is no guarantee that investments will perform well.
So, if your investment decisions are based purely on speculation or favorable performance then what do you do if that doesn’t happen? Sell low? That is exactly what you want to avoid. A defined strategy can help us avoid this type of reactive behavior. Reactive means fear and greed are driving your decisions. Proactive means you have anticipated this situation and your strategy includes guidelines for how to respond. An Investment Policy Statement (IPS) can be a great way to set parameters. This document gives you a clear understanding of the purpose, timeline and expectations for your account.
Creating different “buckets” of money for different purposes can also help you stomach a dip in investment performance. If your investments drop in value but you know you don’t need those funds just yet, then it gives you time to “weather the storm” and wait for them to recover. That is why it is important to have funds that are designated for immediate (or near term) use, to be invested conservatively. An example is an emergency fund or a fund that is intended for a 0-3 year goal.
Avoid investment trends or chasing a hot stock. Instead, create an investment strategy that meets your risk tolerance and financial goals so that you can SaveUp!
This post was written by SaveUp’s personal finance contributing writer, Catherine Hawley, CFP®.
Image source: Mashable