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Headlines don’t tell your story

When making investment decisions, don’t let short-term volatility or headline-grabbing market events derail your long-term goals. Remember your time horizon and take only considered, strategic actions.

January brought the worst start to the year for U.S. equity markets ever. Through January 15, the S&P 500 Index fell 8%. If your portfolio was invested exclusively in U.S. large-cap stocks, then you unfortunately experienced this dramatic drop first-hand. But if you had bonds in your portfolio, they probably rose in value during that time. In other words, if you had a well-diversified portfolio, you did not experience declines as sharp as the short-term stock market losses reported in the headlines.

This principle is important to remember when you’re tempted to react to market events. Basing your investment decisions on the short-term returns of one specific index can harm your long-term goals.

Remember your investment goals

When you consider making changes to your portfolio, remember to consider what you want your investments to do for you, how you feel about market volatility, and when you expect to start making withdrawals from your portfolio. Each investor will answer these questions differently. But, generally speaking, we don’t like to see our investments decline in value, and we are saving for goals that are years or decades away, such as retirement.

This means that a portfolio seeks to balance two conflicting goals: capital preservation and asset growth.

  • A portfolio that attempts to minimize fluctuations in value is unlikely to experience much growth, even over long periods of time. A savings account is one example.
  • A portfolio of growth-generating investments, such as stocks, can experience big and unpredictable drops in value, possibly in short periods of time. Yet, in a long enough time period, such as 10 years, a stock portfolio may outperform the cash portfolio.

Many portfolios hold a mix of assets that perform these rival functions. Over time, history has shown that such a combination has generated positive returns with less volatility than a portfolio wholly invested in U.S. stocks.

Diversification is the tortoise, not the hare

We wanted to prove that a U.S. stock index is not an apples-to-apples comparison with a well-diversified portfolio. We compared the S&P 500 Index with a portfolio diversified across global asset classes of stocks, bonds, alternatives, and other assets from 2001 through 2015.1 In some years, the U.S. index beat the global portfolio, creating temptation for investors to abandon global diversification. However, for the full 15-year period, the globally diversified portfolio outperformed the S&P 500 Index by approximately 1.6% per year on average. It accomplished this with less risk, as well. It had smaller losses in down years and a lower standard deviation, a common measure of portfolio volatility.

What this means for you

In the long term, a well-diversified portfolio has the potential to generate sufficient return to beat inflation and meet your needs. In some years, returns will be high, and in others, they will be lower. So, why would anyone make portfolio decisions based on a one-week S&P 500 Index return?

If you’re shifting your investment mix too frequently (other than rebalancing back to your target allocation), you may be doing harm. Try these long-term fixes:

  • If you want to take on more risk in exchange for greater long-term growth potential, boost your equity exposure.
  • If temporary market swoons give you swoons of your own, increase your allocation to bonds. A portfolio that matches your risk profile should not keep you up at night.

This is why it is critical to understand your goals, time frame, and risk profile and build your portfolio appropriately. Then your portfolio caters not to the whims of the markets but works diligently over the years to build the wealth necessary to achieve your goals.

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