Be it diet, work-life, dance or many sports, “balance” is important – investing is no different.
In the context of investing, we are of course talking about holding a balanced portfolio of investments. It’s called diversification and involves spreading your portfolio across a broad mix of assets. Diversifying your portfolio can help smooth out market ups and downs: so returns from better performing assets help to offset those that aren’t performing so well.
If you don’t know which markets will perform best from year to year (and let’s face it, who does?) holding a diversified portfolio is regarded as the best way of protecting against the unknown. By owning a little bit of many markets, you are ensuring you are in your seat when each market gets its turn at the top and you avoid the pain of having all your money staked on the one at the bottom.
As you can see in the chart below, no single type of asset is consistently best year in, year out.
Unfortunately, when it comes to investment markets it always seems there is something to fret about. Even when looking at the opinions of so-called investment professionals, you do not have to look far to find well-reasoned discussion in support of why markets are about to fall, alongside equally compelling reasons of why they will continue rising.
What is the average investor supposed to make of all this speculation? One way is to try to anticipate what might happen next – but who do you believe? We’ve seen there are always strong arguments for lots of different scenarios, meaning that some will be proved right and some will be proved wrong.
An alternative approach is much simpler. It begins by accepting the market price of an investment as a fair reflection of the collective opinions of millions of market participants. One of the best analogies I’ve come across is to think of the TV show “Who wants to be a millionaire?” and consider how many times the “ask the audience” option comes up with the wrong answer.
Therefore, what really matters is building a diversified portfolio to your own needs and risk appetite, not according to the opinions of media and market pundits about what happens next month or next week.
It also means staying disciplined within that chosen asset mix and regularly rebalancing your portfolio. Without rebalancing, this means that investments that perform well will grow as a percentage of the portfolio, while those that perform poorly will shrink. Left uncorrected, this drift may mean that you end up with more (or less) risk than originally intended. To ensure the portfolio aligns with its target risk and return characteristics, it must be periodically rebalanced to its original target – importantly, you are doing so based on your own needs rather than on what the armies of pundits say will happen in the market next look at this now.
Of course, all this doesn’t mean that you shouldn’t take an interest in global events and news – but it might just stop you worrying about how it affects the value of your investment portfolio.