By Kevin FitzGerald
I’ve recently gone over my brokerage accounts with my accountant, and he made the comment that I should strongly consider establishing an "investment plan." Can you give me some ideas as to some of the key factors to look at?
— S.F., Garden City
In this volatile investment environment, investors may be spending considerable time questioning whether this may be the time to exit the market, or to continue to invest as usual. In any event, losing your long-term perspective can lead to misinformed investment decisions that may make it more difficult to achieve financial goals.
Investors with a long-term investment strategy can proceed more confidently in turbulent markets. These investors tend to know what to expect in terms of risk, return, and market cycles. With this knowledge, they are better prepared to structure a portfolio that will most appropriately meet their needs, regardless of short-term market fluctuations.
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Usually time, not timing, allows an investment to appreciate. "Market timers" — those who try to invest only at the most opportune moments — run the risk of not being in the stock market during periods when the highest results are achieved. According to Paine Webber’s Equity Research department, for example, during the bull market of the last 10 years, a "buy and hold" strategy would have earned an annualized return of 14.7 percent, excluding dividends.
Conversely, an investor who entered and exited the market periodically ran the risk of missing significant trading days. Although past performance does not guarantee future results, the penalty for missing the 40 best trading days of the last 10 years would drop investors’ return to 3.8 percent, excluding dividends.
Not even the experts can predict market highs and lows. However, adopting a long-term perspective can allow many investments to ride out more volatile periods. The longer an investment is held, the lower the average variability of its returns, and, therefore, the greater probability of achieving the investment’s historical average return.
Perceptions regarding risk
While stocks and bonds may offer potentially higher returns than cash reserves, they also expose investors to higher levels of risk.
Most investors understand that higher-returning investments generally involve greater risk. However, these investors typically understand the accompanying fluctuations in the value of their personal portfolios and many have learned to accept the risks associated with markets in which they are investing. Diversification, or investing money among major investment classes, will help diminish risk.
Income needs add another dimension to the structure of your portfolio, as well as to the amount of risk that an investor takes on. For example, if an investor needs to generate steady income to meet cash needs, fixed income investments that can generate consistent income will probably make up a significant portion of his or her portfolio. In contrast, if an investor is not dependent upon a portfolio for current income, the portfolio will generally include a broader range of investments.
A realistic return objective can only be established once an investor’s time horizon, perspective on risk, and income needs are evaluated. A long-term investor, when evaluating his or her portfolio, should gauge the value by taking into account both investment objectives, as well as risk tolerance.
Building a solid portfolio that can withstand market highs and lows should provide long-term investors with the means to meet their investment goals. Accordingly, an investor looking toward the future would be wise not to react rashly when the market swings one way or the other, possibly losing sight of the forest among the trees.
The information contained herein has been obtained from sources believed to be reliable, but we cannot guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.
Kevin FitzGerald is First Vice President-Investments at Paine Webber. He focuses on the areas of professional money management, asset allocation and retirement planning. He can be reached at 1 (800) 654-6162, ext. 448.