Investment Shock Absorbers
Have you ever ridden a touring bicycle down a mountain? I wouldn’t recommend it. Touring bikes are designed for paved roads, so shock absorbers are eliminated to make them lighter and pedal more efficiently.
If you took a touring bike down a mountain, you would end up in a lot of pain. For something like that, you need a mountain bike. They are designed with shock absorbers to cushion the impact of the rocks, logs, ditches and other obstacles you will inevitably confront on the trails.
CAUSES OF A BUMPY INVESTMENT RIDE
Sometimes investors feel like they are riding a touring bike down a rough mountain. Every bump in the markets makes them want to cry out in pain, and they wonder if they’ll ever make it to their final destination. Why is this?
One thing that can make for a really jarring ride is having an undiversified portfolio. If your investments are highly concentrated, every little dip in the markets will be magnified and leave you reeling.
Another thing that will make for a really choppy ride is constantly changing asset allocations based on short-term rough patches in the markets. If you let every market pothole throw you off your bike, you’ll never get anywhere.
HOW TO SMOOTH YOUR INVESTMENT RIDE
So, how can you smooth out your ride? What shock absorbers can you add to your bike to get you down the investment mountain in one piece and enjoy the ride?
Diversification. Spreading your portfolio across different securities, sectors, and countries will even things out and make for a much more comfortable, safe, and enjoyable ride. You will need to identify the right mix of investments, like stocks, bonds, or real estate, that align with your risk tolerance. This will keep you on track toward your goals no matter the obstacles that crop up.
You may not end up with the top performing portfolio, but you definitely won’t have the worst either. This strategy isn’t about being the best, it’s about creating a smooth enough ride for you to hang on until you get to the bottom of the hill. Without these shock absorbers, you are likely to quit halfway down.
IT’S IMPOSSIBLE TO SWERVE AROUND EVERY BUMP
Just as you would try to swerve around everything possible if you were riding a touring bike down a mountain, people with concentrated portfolios resort to market timing and constant trading in an attempt to anticipate the top-performing countries, asset classes, and securities.
This is nearly impossible. Here’s an example of just how unpredictable the ride can be. Among developed markets, Denmark was number one in US dollar terms in 2015 with a return of more than 23%. But if you had bet big on that country the following year, you would have ended up in a ditch. In 2016, Denmark slid to the bottom of the table with a loss of nearly 16%.
Even the US stock market, which is the world’s biggest, can throw you for a loop. It has been a strong performer in recent years, holding the number three position among developed markets in 2011 and 2013, first in 2014, and sixth in 2016. But a decade ago, in 2004 and 2006, it was the second worst-performing developed market in the world.
Trying to predict which part of a market will do best over a given period is also challenging. For example, while there is a plethora of evidence to support why we should expect positive premiums from small cap, low relative price, and high profitability stocks, these premiums are not laid out evenly or predictably across the map. US small cap stocks were among the top performers in 2016 with a return of more than 21%. A year before, their results looked relatively disappointing with a loss of more than 4%. International small cap stocks had their turn in the sun in 2015, topping the performance tables with a return of just below 6%. But the year before that, they were the second worst with a loss of 5%.
If you’ve ever ridden down a mountain, you know to expect the unexpected. There may be a rut or rock pile hiding just around the next turn. It’s important to have a bike with proper shock absorbers to handle whatever may come. Diversification isn’t some kind of magic that will make everything a perfectly smooth ride. But, it does smooth things out so that no individual investment will throw you off your bike. There will still be bumps along the way, but nothing that will keep you from reaching your goals.
DOES YOUR INVESTMENT BIKE NEED A TUNE UP?
Take a look at your portfolio. Does your investment bike need some shock absorbers? You’ve come to the right place because I’m an investment mechanic! With sufficient diversification, the jarring effects of performance extremes level out. Then, you will be able to hang on and enjoy the ride all the way to your investment destination. Click here to schedule a phone call, and we can get your portfolio ready for whatever lies around the next turn in the trail.
Richard Archer is a financial advisor and the President of Archer Investment Management with more than eighteen years of industry experience. Largely working with successful individuals and couples, he specializes in providing comprehensive investment guidance and personalized care and attention to each client. Along with holding a Bachelor of Science in Economics and a MBA, he is a CERTIFIED FINANCIAL PLANNER™ certificant and a Chartered Financial Analyst®. He combines his advanced industry education and knowledge with his genuine care for people to provide clients with an exceptional experience. To learn more about Richard, connect with him on LinkedIn or visit www.archerim.com.