By Brandon Miller, CFP–
Wall Street certainly has done a good sales job on the American people. Nightly newscasts, newspapers, and online information sources all dutifully report the ups and downs of the Dow, S&P, and NASDAQ like it’s a sporting event. Individual stocks get singled out for extraordinary gains or losses and are declared that day’s winner or loser. Companies that beat earnings’ expectations for a given quarter become market darlings, often regardless of what’s going on within the organization or the world.
Each fluctuation can cause a new round of “should I buy, should I sell, should I worry, am I missing out” anxiety. But in truth, market swings can be much less of a factor in accumulating wealth than the media’s play-by-play coverage would have you believe.
To show you what I mean, let’s do a quick refresher on what really builds financial success. Number one is time in the market. There is no substitute for investing over a long period of time because you get the advantage of compounded growth—a fancy way of saying making money on your money. Second is cash flow or how much money is coming in and how much is going out. Third is your tax bill, which is why tax-advantaged retirement accounts can be such a win-win.
These three factors determine how much you have to invest. And that leads to the next step, which is determining where to invest. Here, too, there are three factors that can impact your success. They are asset allocation (the pie-chart thing), investment selection, and market timing (when you buy or sell investments).
Care to hazard a guess as to which is the most important … by a whopping margin?
It’s asset allocation. It turns out that having a variety of pies in different size slices is more important than the actual ingredients they’re made of.
A famous study from 1986 in the Financial Analysts Journal—backed up by subsequent research over the years, including Scott et al. in 2017—showed that asset allocation accounted for over 90% of a diversified portfolio’s return patterns over time ( https://tinyurl.com/2bt2kc8w ). Less than 9% was due to investment selection or market timing, Vanguard later reported.
So, chasing hot stocks and trying to perfectly time buying low and selling high has way less impact—and takes way more energy—than developing a smart asset allocation strategy tailored to you.
When you think about it, asset allocation’s success makes total sense. In any market, some types of investments do well while others struggle. What’s up and what’s down is always changing. Asset allocation spreads your investments across various asset classes—stocks, bonds, cash equivalents, etc.—to capitalize on any given market’s winners and minimize the impact of the losers. Diversifying within each asset class (mutual funds are great for this), and investing across industries and even countries can position your portfolio to better handle the market’s inevitable swings.
The aim of asset allocation is to take on the minimal amount of risk needed to achieve the level of return your goals require. That means you have to know two things: your risk tolerance, which myriad online sources can help with, and your time horizon. Wanting money in two years for a down payment requires a whole different allocation strategy then retirement savings that won’t be needed for 20 years.
As to how to allocate your investments, you can find model portfolios that provide a guide to the asset types and proportions of each to hold based on the money you have to invest, plus your timeframe and risk level. Financial professionals can create customized portfolios and accommodate special requests, such as keeping cigarettes out of your investment mix. Passively managed investments, including index funds and exchange traded funds (ETFs), can provide a low-cost option for instant diversification.
Regardless of how you deploy an asset allocation strategy, remember that it’s not a one-and-done decision. Your timeline is always shortening and your goals or circumstances may change. Or tremendous growth in one area can knock your asset allocation out of whack and make you more vulnerable to market downturns in that sector. Rebalancing periodically can keep your investment mix in line with your goals while shedding unnecessary risk.
With asset allocation driving your dreams, you can tune out all the breathless reporting about Wall Street and know that you are safely strapped in, ready to handle wherever the road goes.
Brio does not provide tax or legal advice, and nothing contained in these materials should be taken as such. The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. Any past performance discussed during this program is no guarantee of future results. Any indices referenced for comparison are unmanaged and cannot be invested into directly. As always please remember investing involves risk and possible loss of principal capital; please seek advice from a licensed professional.
Brio Financial Group is a registered investment adviser. SEC Registration does not constitute an endorsement of Brio by the SEC nor does it indicate that Brio has attained a particular level of skill or ability. Advisory services are only offered to clients or prospective clients where Brio Financial Group and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Brio Financial Group unless a client service agreement is in place.
Brandon Miller, CFP®, is a financial consultant at Brio Financial Group in San Francisco, specializing in helping LGBT individuals and families plan and achieve their financial goals.
Published on February 10, 2022
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