One of the ways to reduce your exposure to the different risks in the market is by spreading your holdings across the market
Apps like robinhood, through notifications, encourage investors to constantly monitor their portfolios and worry about short term results. However, this is wrong. It’s okay to check on your portfolio performance sometimes but focusing on the short-term results will lead you to make irrational decisions. For example, during the Great Recession, a large market selloff occurred and a lot of investors thought they were smart by exiting their position before losing anymore money. However, the investors who held onto their positions, regained all their losses and made profit. Financial loss may be painful but it is only temporary.
Rather than comparing your portfolio performance to someone else’s, compare your performance to major benchmarks like the S&P 500 or Nasdaq, to understand how your portfolio compares to the overall market performance. If you find that your portfolio is constantly lagging behind its benchmark, then it’s time to invest in other securities. The best way to do this is through diversification.
Let’s say you wanted to invest 50% of your capital in stocks and 50% in bonds but your equity assets yielded a much higher return than your fixed income assets this year. As a result of this, your exposure to equities increases because the market value of your equities is now greater than the market value of your fixed assets. To return back to your 50/50 asset allocation, you would either have to buy more bonds or move some money from your equities to your fixed asset. If you fail to rebalance, you could find your portfolio risk skyrocket and stray away from your risk tolerance.
In addition to this, global events have a large impact on your portfolio. For example, during the COVID-19 pandemic, we saw a dramatic fall in equity ownership as investors moved their money into fixed income securities and commodities. This was because the future was unknown, the economy was unstable and investors wanted to make sure their money didn’t vanish. As lockdowns eased and vaccinations accelerated, the equity market started to boom, eventually reaching an all time high in Aug 2020. Hence, you must rebalance your portfolio as the environment and your risk tolerance changes.
Morgan Housel wrote in “The Psychology of Money” that Warren Buffet’s skill was investing but his secret was time. He had started investing as a young man, building up his portfolio from the first chance he got. Making small regular investments is the best way of meeting a big financial goal. The sooner you start investing, the more time your investments will get to grow and the more experience you will develop. The more you learn, the more return you potentially earn.
One of the benefits of regularly investing is dollar cost averaging. By regularly purchasing shares, the variety of prices at which they have been bought, will cause the average cost of shares to decrease. Note: always buy more shares when the market price is lower than your average cost as this will bring down your average cost further and increase your holding value. For example, buying 100 shares at $100 and then 100 shares at $80 will cause the average cost of your 200 shares to be $90.
At the end of the day, the objective of investing is to meet your financial goals: generating passive income, saving for college or retirement. The beauty of investing is being able to take your financial goals into your own hands. If you need to save up for college/retirement and you only have a limited amount of time, invest in riskier assets in hopes of gaining a higher return. However, if you’ve started investing early, then balance your portfolio in terms of asset allocation. At the end of the day, your portfolio should reflect your financial goals and characteristics.