Friday, May 14th, 2021
A successful investor aims to maximize gains while minimizing losses, which can be a delicate balance. While no investment strategy can completely avoid risks or guarantee perfect outcomes, there are steps you can take to improve your approach. Here are six foundational principles that can help you invest more confidently and effectively for the long term.
Long-Term Compounding: Growing Your Nest Egg Over Time
Think of compounding as a “snowball effect” that gains momentum the longer it’s left untouched. Compounding allows your earnings to grow on top of previous earnings, creating the potential for impressive growth over time.
For example, if you invested $10,000 and left it alone with an average annual return of 8%, after 20 years, it could grow to over $46,000. In 25 years, it could exceed $68,000! By allowing investments to compound, you give yourself a chance for substantial growth without additional contributions.
Embrace Short-Term Pain for Long-Term Gain
Sticking with your investments during market fluctuations is easier said than done. Watching the market decline can stir up anxiety and tempt you to sell. However, staying the course with a well-diversified portfolio increases your potential for gains over time. Although past performance doesn’t guarantee future results, history shows that the market has trended upward in the long term.
Diversifying across different assets can further support stability, as some assets may perform well even during market downturns. While diversification doesn’t protect against loss, it does help spread risk and offers a way to manage uncertainty effectively.
Diversification: Allocating Assets Wisely
Asset allocation is the practice of spreading investments across various categories—such as stocks, bonds, and cash—to manage risk and maximize returns. This principle is crucial because your mix of assets plays a significant role in overall performance. According to Modern Portfolio Theory, the way you divide investments between asset types can drive as much as 90% of your portfolio’s return.
Allocating your funds across asset classes that respond differently to market forces can also reduce volatility. For example, when stocks dip, other assets like bonds may provide balance. Ultimately, strategic asset allocation creates a well-rounded portfolio, giving you resilience in various economic conditions.
Prioritize Liquidity When Needed
Liquidity, or the ease of converting assets into cash, is essential if you anticipate needing funds soon. Generally, the closer your financial goal, the safer it is to keep funds in low-volatility investments, like short-term bonds or cash equivalents, to avoid forced sales at inopportune times. For immediate needs, investing may not be the ideal choice, as investments are more suited for long-term growth.
Invest Consistently with Dollar-Cost Averaging
Dollar-cost averaging is a simple, steady approach to investing. By investing a fixed amount at regular intervals, you accumulate more shares when prices are low and fewer shares when prices are high. Over time, this strategy often results in a lower average cost per share, as your fixed contributions continue regardless of market ups and downs. For dollar-cost averaging to be effective, commit to investing regularly, even during market dips.
Review and Rebalance Regularly
A “buy and hold” approach can be powerful, but it’s essential to periodically check in on your portfolio. Circumstances and goals can evolve, and economic conditions may shift, affecting your investments. Additionally, some assets may grow faster than others, leading to an unbalanced portfolio.
To maintain your target allocation, consider rebalancing periodically. This process involves selling assets that have grown beyond your desired proportions and reinvesting in those that have lagged, bringing your portfolio back in line with your goals.
Many advisors suggest rebalancing at least once a year, though more conservative investors may benefit from more frequent adjustments. Be mindful of potential fees and tax consequences when rebalancing, and consult a financial advisor if needed.
By applying these principles, you can make more informed decisions and stay aligned with your long-term financial goals. As always, a steady, thoughtful approach helps you build a portfolio suited to weather both the highs and lows of the investment landscape. If you have any questions or would like personalized guidance, don’t hesitate to reach out to Navalign Wealth Partners. Our team is here to support you every step of the way on your investment journey.