April is Financial Literacy Month, so even if you’re a seasoned investor, boost your acumen with these key investing concepts.
Whether you’re currently partnering with a Financial Advisor, or managing your own portfolio, it’s never a bad idea to to refresh yourself on some hallmark investing maxims. Here are seven considerations that stand the test of time.
Portfolio diversification is perhaps the most basic component in building stable, long-term investment returns. History shows that the relative performance among different asset classes often spans a very wide range. The best-performing asset classes in one period can sometimes be among the worst the following period. A smart way to cope with that challenge is to maintain a diversified portfolio. By using a range of asset classes such as equities, fixed income, foreign investments and commodities, among others, you can more effectively manage volatility during challenging market cycles. Portfolio diversification does not provide immunization from severe bear markets, but it can mitigate the damage they inflict.
Successful investing involves patience and fortitude. No other piece of investment advice is as consistently sound as playing the long game. Markets will always have ups and downs, but over the long term the average investor can profit. The reason is that time is a form of diversification. As the chart below shows, the longer the holding period, the more reliable growth-oriented investments can become.
Your financial choices and decisions should be based on your objectives, risk tolerance and time horizon—not on what everyone else is doing, or worse, moves based on market panic. “The stock market essentially is a crowd,” says Dennis Lynch, Morgan Stanley Investment Management’s Head of Growth Investing. “It reflects the aggregated view of all the participants. So in order to beat the market you have to be willing to be different from everyone else.”
Moving money into and out of the market in anticipation of corrections comes with a host of potential consequences. In the chart below, you can see that the S&P 500 from 1990 to 2016 shows annualized returns were 9.3% with no missed days. If you missed just 15 of the best days over that entire 26 year period, your returns would shrink to 5.4%.
While there is risk involved in investing, knowing your tolerance to risk—that is, how comfortable you are investing through market cycles that may produce negative returns—will help you determine the investment strategy that’s right for you. The three main types of risk are inflation risk, which is the risk that your investment might not keep pace with inflation; market risk which is the risk that a market may go down in value; And principal risk, which is the risk of losing money that you invest. Understanding all three is key to becoming a more savvy investor.
Even the most unemotional investor can fall prey to behavioral investing traps. One typical bias is anchoring, where an investor fixates on a certain price levels such as the price paid for a particular stock. If new information becomes available or the investment landscape changes, it becomes a trap to look at the price of a stock as it “should be.” Another bias is mental accounting where an investor divides wealth into arbitrary categories and makes irrational decisions based on the category, such as a stock purchase or sale tied to an emotional attachment to the company.
Remain flexible when it comes to your investment plan. “The key to successful investing is not getting too dogmatic with your views,” says Mike Wilson, Chief Investment Officer for Morgan Stanley Wealth Management. “It’s important to understand that the world is a changing environment and the rate of change is often what drives investment success or failure.” Be willing to change your strategy as global markets, tax policies and interest-rate environments shift. It is also important to revisit your investment strategy as your goals, life situation and cash flow needs change.
Investing wisely is essential to reaching your financial goals. And knowing which investments are most appropriate for you, what strategies make the most sense and how best to execute them requires in-depth knowledge and experience. A Morgan Stanley Financial Advisor can help you create an investment strategy geared to your specific needs, risk tolerance and time horizon—charting a course that will help achieve all of your goals.