Young Investor’s Guide to Building a Financial Future- Follow a Plan that Fits Your Goals
Part 5
Avoid Speculating
Focusing attention on broad market indices can also help you avoid speculative behaviors that tend to have a negative impact on your long-term returns. These include market timing and stock picking.
Attempts at timing the market - buying and selling stocks based on breaking news and short-term market movements - often turn out poorly. Because you’re typically buying into hot trends and selling when conditions are scary, you end up buying when prices are high or selling when prices are low. In both cases, that behavior can take a big bite out of your savings, causing major setbacks as you work toward your long-term financial goals.
In fact, investors’ poor track record around market timing is well known to researchers. A long-running annual survey of investor behavior by DALBAR found that the average equity fund investor trailed the S&P 500 by roughly 5.5% in 2023 due in large part to poor decisions surrounding when to buy and sell.
Meanwhile, stock picking can overload your portfolio with too-few individual securities. This reduces your diversification and introduces something known as concentration risk. Investors are typically rewarded for taking on systematic risk, or risk inherent to the entire market. Concentration risk is not systematic. Rather, it’s particular to the stock you hold, and as such, you cannot expect to be consistently rewarded for taking it on.
If you hold a large portion of your portfolio in just a few stocks, each holding can have an out-sized effect on your portfolio. Should something happen to just one of the companies you happen to hold - bankruptcy, for instance - you could lose a big chunk of your savings.
It's also exceedingly difficult to pick stocks that will outperform the broader market over time. Consider that in 2023, more than 70% of companies in the S&P 500 Index underperformed the index. These results vary from year to year. But since a handful of companies often drives most of the stock market’s returns, choosing just when to sell the future losers and buy the next big winners can end up becoming an impossible - and often losing - game.
In short:
Timing the market can lead you to buy stocks when they’re expensive and lock in losses by selling during downturns. When it comes to stock picking, it’s exceedingly difficult to pick single stocks that will be winners, and holding concentrated stock positions can introduce uncompensated risk to your portfolio. Instead, build a diversified portfolio as part of your long-term financial plan.
Follow a Plan That Fits Your Goals
So how should you divvy up your diversified investments? Start with your asset allocation, which is how your portfolio is spread among asset classes including stocks, bonds and cash. Then base your asset allocation on your personal goals, tolerance for risk and the length of time you have to invest.
If you search the internet, you’re likely to instead come across various rules of thumb to help you choose how to allocate your funds, such as the “your-age-in-bonds” rule. This rule suggests you hold a percentage of bonds equal to your age. A 30-year-old would supposedly hold 30% of their portfolio in bonds and 70% in stocks, for example.
Be wary of rules of thumb like these. They depend on broad averages, not your individual circumstances. Also, it can be ill-advised to reconfigure your portfolio too frequently or based on something as distracting as whether you’re 29 or 31 years old. With years ahead of you, if you’re able to remain calm and invested during the market’s inevitable rough patches, a healthy dose of stock market returns can take you far.
In short:
Build your portfolio based on your personal goals, risk tolerance and time horizon rather than chasing or fleeing hot or cold investments or focusing on generalized rules of thumb.
Interested in learning more about how to take the first steps toward meeting your personal financial goals? Reach out to set up a time, and let’s talk.