The key to successful investing
A question that is commonly asked in times of market volatility is "Should I invest or keep my savings in safe Certificates of Deposit?" Even if the questioner is stuffing their cash in a mattress, they are "investing." Thus, the question that should be asked is, "How will I invest my funds?"
For many investors, the stock and bond markets are just too risky. These investors are often choosing such investments as one year CDs. One year CDs yield approximately 0.6 percent. At the end of August, the US inflation rate for the past 12 months was 3.8 percent. When we consider the real rate of return (total return less inflation rate) for one year CDs, they currently provide a -3.2 percent real rate of return.
On the opposite extreme is an investor that is 100 percent invested in the US stock market. From the beginning of 2007 through the end of Q2 2011, the annualized investment rate of return for the S&P 500 (with dividends reinvested), was 0.4 percent. With the recent volatility the S&P 500 annualized return declined to -2.6 percent by the end of Q3.
Is a guaranteed -3.2 percent real rate of return better or worse than a volatile rate of return created by investing in the markets? Investment studies have shown that the most critical requirement for investment success is to develop an investment plan and stick with it through both good and bad markets.
Studies show that investors consistently underperform stock market benchmarks. This performance is not related to an investor picking the wrong stocks or mutual funds. Most of the long term investment underperformance occurs because investors often buy when markets are high and sell when markets are low. Whether the investment approach is conservative or aggressive, these studies show that long term investment results are consistently higher when the investment approach is maintained throughout a full market cycle.
A conservative investor will typically significantly outperform an aggressive investor in down markets. Unfortunately, in frothy up markets, conservative investors are often tempted by the significant gains that their more aggressive investor friends are receiving. At the worst possible time (when stocks are overpriced) these conservative investors often decide to become more aggressive investors. By changing their investment approach, their funds are often decimated by the next market downturn.
Aggressive investors will typically significantly underperform their conservative counterparts during a down market. In desperation, aggressive investors often sell much of their stock market investments at the worst possible time (when stocks are underpriced). By changing their investment approach, aggressive investors will not be fully invested in the stock market when the markets stages its next recovery.
Financial Abundance, LLC, uses a diversified investment approach that includes US and international stocks and stock funds, US and global bonds and bond funds as well as some exposure to "alternatives" such as REITs, gold, commodities and currency funds. We seek out value oriented investments that typically provide better than average dividend payouts. This approach helps decrease a portfolio's volatility and increase the total return.
Whether your investment approach is conservative, aggressive or somewhere in between, the key to long term investment success is maintaining a consistent approach through up and down markets. Fear and greed are two of our most common investment nemeses. If you are susceptible to one or both of these, find a fee only investment advisor to help manage your investments. At Financial Abundance, LLC our primary added value is our ability to remain consistent with our investment approach, through up and down markets.
After reading many investment studies, a consistent conclusion is that investors can be successful as aggressive investors, conservative investors or anywhere in between. Regardless of investment approach, the two primary components of successful investing are portfolio diversification and consistency.
Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor, providing fee-only wealth management services. He is the author of "Financial Abundance Guide," available free at www.finabguide.com . He can be reached by email at email@example.com or at 303-554-0309.