By FPA member Marguerita Cheng, CFP®, CRPC®
Last Updated: September 6, 2011
Volatile global financial markets, political issues, budgetary concerns, unemployment, debt crises, etc. These headlines can heighten your fears, cause panic and jeopardize the integrity of your retirement investment strategy. It isn’t about trying to time the market, rather the time you’re in the market. Here are some tried and true investment strategies to help you stay on course.
While it may seem counter intuitive, it is an opportune time to invest additional dollars for your retirement. With a dollar-cost averaging strategy, you commit to investing a fixed amount on a regular basis, regardless of market conditions. In other words, in a “bull market” when prices rise, fewer shares or units are purchased and in a “bear market” when prices decline, more shares or units are purchased. In fact, many investors implement a dollar-cost averaging strategy within their employer sponsored retirement plan. This strategy does not guarantee a profit or protect against loss in a declining market, but it can mitigate the risk of investing based on emotion.
An investment strategy that can reduce volatility in a portfolio is to diversify or spread the risk across diferrent types of investments or “asset classes.” Market conditions that may cause one asset class to outperform may cause another asset class to underperform. By having exposure to different asset classes, you may be able to counteract your losses in that asset class with better investment returns in another asset class. Building a diversified portfolio can not only help minimize volatility in your portfolio, it can potentially generate more consistent risk-adjusted returns.
A diversified portfolio should be diversified at two levels: between asset classes and within asset classes. In addition to allocating your investments among equities/stocks, fixed income/bonds, cash equivalents, commodities, precious metals, real estate, etc., you will also need to further diversify your investments within each asset class. One way to diversify your investments among stocks is by market capitalization: international stocks, large capitalization or “large cap” stocks, medium capitalization or “mid cap” stocks, small capitalization or “small cap” stocks, “micro cap” stocks, emerging market stocks, etc. Stocks can also be further diversified by sector, industry or style (growth vs value).
Diversification does not stop or end with equities/stocks. You will need to diversify the risks with your fixed income/bond investments by duration/maturity and quality/credit. Selecting bonds from different issuers can protect you from the possibility that any one issuer will be unable to satisfy its obligations to pay interest and principal. Incorporating different types of bonds (government, agency, corporate, municipal, mortgage-back securities, etc.) can protect you from the possibility of losses in any given sector of the bond market. Your financial goals, objectives, tax situation, and risk tolerance will determine the appropriate allocation of municipal, government, corporate, mortgage-backed, asset-backed securities, international and emerging market bonds.
While diversification can reduce the volatility in a portfolio, market volatility can wreak havoc on even the most perfectly diversified portfolio. Over time, investments that have performed well will represent a greater percentage of your portfolio and those that haven’t will represent a lesser percentage. As a result, you need to readjust your portfolio to its original investment allocation. If your investment goals and objectives haven’t changed, then your portfolio investment allocation shouldn’t either. Rebalancing requires that you take some gains off the table or “sell the winners” and reinvest the proceeds in an asset class that has been underperforming or “buy the losers.” When executed, this strategy will help you buy low (the losers) and sell high (the winners) without the guesswork and temptation to time the market. Just like dollar-cost averaging, the discipline of rebalancing your portfolio can help you stay on course and prevent you from making investment decisions based on emotions.
FPA member Marguerita Cheng, CFP®, CRPC®, is a financial advisor at Ameriprise Financial Services, Inc. in Bethesda, Md.