An Investor's BFFs: Diversification, Patience, and Consistency
Fall is here. The air is crisp, the leaves are raked (until next week) and the bulbs are planted…flowering bulbs of varying size and color….arranged so there is continuous color from early spring to the late fall. The bulbs will shine bright if the soil conditions are right and the weather cooperates. And of course if the squirrels don’t dig them up and have a winter feast. And later at their peak, you may need to safeguard the blooms from deer that come looking for a late night snack.
Gardening is time consuming and not a hobby for those who like to see their results straight away. It takes patience, consistency and diversity, …. These are three friends to call on when investing as well. And regardless of how the markets perform, they should be a part of your investment philosophy.
Diversification or “not putting all your eggs in one basket” has real value when it comes to both gardening and investing. A diverse selection of flowering bulbs and plants increases your chances of having a colorful garden in spring, summer and fall. In the financial world, these seasons represent different market cycles. In a bear market, certain asset classes may perform better than others. Ditto for a bull market. If your assets are mostly held in one kind of investment (say, mostly in mutual funds, or mostly in CDs or money market accounts), you could be hit hard by stock market losses, or alternately lose out on potential gains that other kinds of investments may be experiencing. So there is an opportunity cost as well as risk.
This is why asset allocation strategies are used in portfolio management. After determining your goals and tolerance for risk you then assign percentages of your assets to different classes of investments. This diversification is designed to suit your preferred investment style and your personal objectives.
Patience is indeed a virtue in investing as well. Impatient investors obsess on the day-to-day doings of the stock market. “Stock picking”, “market timing” and “day trading” are all attempts to exploit short-term fluctuations in value.These investing methods might seem fun and exciting if you like to micromanage, but they will add stress and anxiety to your life, and they are a poor alternative to a long-range investment strategy built around your life goals.
It’s important to remember the longer you stay with a diversified portfolio of investments, the more likely you are to reduce your risk and improve your opportunities for gain. Though past performance doesn't guarantee future results, the long-term direction of the stock market has historically been up. Take your time horizon into account when establishing your investment game plan. For assets you'll use soon, you may not have the time to wait out the market and should consider investments designed to protect your principal. Conversely, think long-term for goals that are many years away.
And what about consistency? Most people invest a little at a time, within their budget, and with regularity. They invest $50 or $100 or more per month in their 401(k) and similar investments through payroll deduction or automatic withdrawal. In essence, they are investing on “autopilot” to help themselves build wealth for retirement and for long-range goals. Investing regularly (and earlier in life) helps you to take advantage of the power of compounding as well.Compounding is your best friend. The longer you have your money working for you, the more you will gain. It's the "rolling snowball" effect.
Are diversification, patience and consistency part of your investing approach?