Updated: Mar 31
It’s not an escalator to wealth at the top of the stock market, and that’s why you need to plan for all types of obstacles and change your strategy along your investment journey.
If there is clear evidence from the last couple years, it is easy to do well when the market is rising. Everyone can make a buck when a rising tide lifts all boats, but the real challenge is when a storm sets in. This is akin to Warren Buffett’s famous quote “…only when the tide goes out do you discover who’s been swimming naked.”
Investing is much like climbing a mountain. It’s not an escalator to wealth at the top of stock market, and that’s why you need to plan for all types of obstacles and change your strategy along market conditions and stages of your investment journey. And just like if you encountered stormy waters, a sudden market downturn is the true test for investors and their theses. Let’s be realistic, investing is all about the ups and downs. If it were all about the ups, it would be all too easy.
We’ve previously discussed the inability to know the future, and while no one can accurately predict tomorrow, let alone what the market might do in ‘x’ months, the key today is to ensure you have the knowledge to safeguard your portfolio when the tide turns.
There are only so many things we can control, and the market is not one of them. We need to manage risk and expectations for the duration of our investing journey. Here are three key factors to help navigate investment ups and downs.
1. Make sure your portfolio is truly diversified
Diversification is one of the most simple yet effective means to ensure that you can ride out the ups and downs of investing. The saying that you shouldn’t put all your eggs in one basket rings true in the stock market.
Exposure to different stocks, sectors and geographical regions of the market reduces your risk, smoothing out returns and shielding your portfolio if a stock or sector becomes out-of-favour.
It’s not just exposure to different stocks or industries that is key to reducing the risk tied to any individual asset class. Instead, exposure to international stocks and different asset classes helps. Just look at your super fund. Notice how diverse your portfolio is?
Remember, “Diversification is the only free lunch” in investing as attributed by Nobel Prize laureate Harry Markowitz.
2. Invest for the long-term when time is on your side
It’s easy to get caught up in the day-to-day gyrations of the stock market, but ask yourself, would you check the value of your home every day? After all, it’s another asset, right?
If you’re young, with a long investment horizon ahead of you, your approach to investing should generally be for the long-term. It’s important to focus on building wealth over time, taking advantage of compounding, rather than trying to emulate a get-rich-quick story.
Sure, there will be downturns, but the market has consistently bounced back time and time again. That’s why it’s important to ignore the noise and stop worrying about short-term fluctuations and instead think about your long-term goals.
3. Ensure you have an appropriate asset allocation in place
All of us should ensure that we have an appropriate asset allocation in place that is tailored to each individual life stage and our circumstances at that point in time. We should also update it through our investing journey. As Benjamin Franklin once said: “If you fail to plan, you are planning to fail”.
This takes on even greater importance for individuals approaching or entering retirement. It may make sense to target growth during earlier parts of your life, but once retirement beckons, it is more prudent to invest for income and to prioritise capital preservation when markets turn pear-shaped.
Those approaching retirement age or drawing an income from their super should generally seek more stability and predictability, which naturally works to mitigate risk through the ups and downs of investing. On the other hand, younger investors can prioritise capital growth knowing they have time on their side to recoup losses.
It is easy to become complacent and expect the market to continually rise, however, there will always be setbacks along the way. Those downturns might not be so pronounced on a long-term chart, but it is easier to ride out the ups and downs of investing when you have a diversified portfolio, invest with a long-term mindset when time is on your side, and you tailor your asset allocation to match your individual life stage.
Have a great week,
George Wong - Certified Financial Planner