Most investors invest their money with the long term goal of retirement investing in mind. Some undoubtedly have shorter term goals like a new house or paying for a child's college, but I'm willing to bet the lion's share of investors are thinking about their golden years when making the conscience decision to save and invest. If those investors are in their 30s or 40s, a traditional retirement is still 20 to 30 years away. How curious then, that they panic whenever the stock market has a correction. I understand that no one wants to lose money, even when it is just paper losses. I am an investor in my 30s. I do not expect social security (or any government program for that matter) to help me in retirement. Investors my age need to develop their own plan for a financially stable retirement. Mostly I invest for retirement, hopefully an early retirement, but a goal that is years off all the same.
I see many of my fellow investors making huge blunders, the biggest of which I've written about in a pair of articles called The Eighth Deadly Sin: Chasing Yield and Following The Crowd: The Ninth Deadly Sin. Unless you are a "pure alpha" investor, you will get the most consistent return by developing a balanced portfolio which meets fits your goals and lifestyle. (By "pure alpha" investor, I mean someone who is a full time active investor looking to get in front of each and every stock market move). By rebalancing the portfolio to your target asset allocations once or twice per year, you can also minimizing trading costs. Another benefit of this approach is capturing most of the price appreciation of the portfolio's best performing assets and reinvesting in the assets that underperformed.
Some investors wonder why they need a diversified portfolio of assets at all. Why can't they just invest all their money in the assets that will do the best for the next year, and change at that time? My guess is those investors either haven't been investing very long, or have a crystal ball that reveals the future. My crystal ball is broken, so I don't know which assets will outperform in a given year. I do however, know the benefits of investing in a diverse group of assets. Let's look at a few assets below.
The goal is to invest in truly non correlated assets. Unfortunately, in recent years global asset markets have become much more correlated. Perhaps when central banks quit meddling in various global asset markets, things will return to normal. Or perhaps not. Even today, I contend there is a benefit to diversification for the average investor. We are going to take a look at the price charts (by Yahoo Finance) of three asset classes below. As a proxy for the asset classes we are going to use Vanguard's Total Stock Market ETF (NYSEARCA:VTI), Vanguard's Total Bond Market ETF (NYSEARCA:BND), and the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM). They represent the total U.S. stock market, total U.S. bond market, and emerging stock markets, respectively.
Vanguard's Total Stock Market ETF
Vanguard's Total Bond Market ETF
iShares MSCI Emerging Markets ETF
What do you notice about the prices of these assets over the past seven year? Your first observation might be that all three asset classes crashed at roughly the same time (late 2008/early 2009). That's true, although I would be quick to point out that the U.S. bond market proxy (Vanguard's BND) went down less and recovered more quickly than the other two. This is the type of performance I would expect from bonds historically. The next thing you may notice is that the emerging stock market proxy (iShares' EEM) sold off sharply and recovered in 2009, but the price has gone sideways since the beginning of 2010. Then of course, there is the U.S. stock market (represented by Vanguard's VTI). It has steadily marched higher since early 2009, with very few bumps along the way. Some would argue that the unconventional policies of central banks around the world have encouraged the prices of both bonds and stocks to climb. I think those people are correct, but that's a conversation for another time.
What is more important is that eventually both stocks and bonds will change coarse and head lower. I do not know when that will be, and honestly doubt anyone does, but it will eventually happen. I would guess it won't happen at the same time, either. History is full of periods of both rising and falling asset prices. The average investor's goal should be to sell some outperforming assets and buy some under performing assets, at regular intervals. So if you want a tip, might I mention that I rebalance my portfolio systematically. Stock and bond prices are not a one way trade (read higher), recent history not withstanding.
If you're looking for a simple approach to your portfolio, take a look at the one I outlined as a game plan for my own portfolio in this linked Seeking Alpha Article. These 4 or 5 index ETFs will give my portfolio the exposure to several non correlated (typically) assets, while minimizing investment fees. This portfolio will also free up a lot of personal time, while also taking some of the emotion out of my investing decisions. It's just a thought, but I think it's a pretty good one.
I do not own any of the ETFs mentioned in this article. This article is for informational purposes only and intentionally discusses ETFs I do not own. This article should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above is provided by Yahoo Finance
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.