Let’s start investing. Let’s start building up assets. Let’s start going down the MoneySense road that leads to financial independence.
The MoneySense investor, the person who ultimately achieves a goal, has at least two important characteristics: this person has spending commonsense and a balanced investment approach.
This means he or she is ready to commit to spending discipline and to investing on a regular basis, such as each pay period or once a month, over the long term. This sage soul will also use different kinds of investments.
This is a balanced approach that reduces risk. This person doesn’t put all his or her investments in one stock or even just in stocks in general or does all his or her investing over a short period.
What’s dangerous about the latter? Bad things can happen if the investor dumps a bucketload of money into the market when it is about the make new highs and is now oversold. The balanced investor, the one who consistently invests over long periods, isn’t trying to guess at market highs or low.
The MoneySense investor also has a diversified plan for today, tomorrow and ten years from now. He or she also has a mix of stocks and bonds as well as possibly a few other things. This person may own his or her house or apartment in an expensive city, expecting to sell it at a profit and later move to a cheaper city. He or she may own a second apartment or home as an investment. The idea is to diversify across several different kinds of investments.
How Does One Allocate Assets?
Many correctly argue the asset allocation decision is the most important driver in investment returns. Asset allocation means how you spread out your investments. What percentage will go to stocks, bonds, cash and real estate etc. The most common long-term asset allocation, for those with twenty years or more to invest, tends to be sixty percent stocks and forty percent bonds.
Ken Fisher, a long-time investment adviser and money manager, makes that argument. He writes asset allocation is critical to any successful plan. And having diverse investments in a plan is very important, he believes.
One can‘t get from Point A—someone with little or no assets, to Point Z, someone with substantial assets, enough to achieve financial independence—without a road map.
Why, an adviser such as Fisher asks, are you investing without a long-term plan? That’s not the MoneySense investor. He or she puts his or her money in more than one kind of investments.
These different ways of investing are called asset classes. These include stocks, bonds, real estate and other things such as cash, such as money market accounts. By the way, we will later see that cash can, in some limited circumstances, actually be the best “investment.”
Buy on the Cheap
Some of the principles the MoneySense investor uses include: Buy low expense investments, preferably index funds, and be sure you mix your investments. The latter should include both stocks and bonds, but it should never be just stocks or just bonds. You should also have a bit of cash, which, in bad times, can be your best investment.
The reason for diversification is that no one can know with certainty if the next investment cycle will be bad for stocks or for bonds or any investment. Bonds and stocks tend to move in different directions. Stocks, long term, do better than bonds over the long term.
So why not put all your money in stocks?
If you are an aggressive investor and if you are very young, with decades to recover from losses, an argument can be made for a stock only approach for a while. But most people don’t have limitless time to invest—I only seriously started in my late 30s—and many people don’t have the stomach to hang in for decades to get good returns. They often interrupt their investment efforts to spend on what often turn out to be superfluous things or they stop investing because they are facing a bad period. And there is something else: In some periods, not all or most, bonds have beaten stocks.
Not recently as stocks have been great for more than a decade as I write this.
I’m not sure exactly when. But I know, that over almost any given 20-year period, that bonds will sometime beat stocks.
Don’t Make One Big Bet
So the most important thing the investor should remember is don’t put all your eggs in one asset class basket. This way, when stocks are down, your bond investments will likely be doing well. In a diversified portfolio, the reverse will also happen—a bad time for bonds generally will mean stocks shine.
Diversification carries the investor through rocky times. It doesn’t guarantee that he or she will never lose money. But what it does is give one a better chance to lose less in bad times. Example: Markets were generally down in the United States in 2008 some 35 percent to 40 percent. I know some people who actually lost 50 percent and they vowed to never invest again.
Did my wife and I, who had bonds as well as stock funds, take a hit in 2008?
You bet. But we were “only” down some 25 percent because we were diversified and had not put all our investments in one thing, or asset category. We had a fair amount in bond funds. Our losses in 2008 were painful, but not nearly as painful for many other investors who insisted on stocks and nothing else.
So we survived into 2009. That’s when markets recovered and we got a lot of our losses back from the previous year. Indeed, the stock market over the last decade, until the recent crisis of early 2020, has been a great place, but it doesn’t always do well.
Recently more bad times came for the stock market, but they recently passed. Why will the next bear market come? It will depend on some factors that are unpredictable. Example: Who could have predicted a couple of years ago that the Coronavirus would have such a profound effect on the economy and markets?
So, since the long-term stock market tends to go down one out of three years, and since the stock market until recently has been in a long-term bull market, the odds are good that, sooner rather than later, we’ll get a bear market. Indeed, now, owing to the Coronavirus, we were in one, but it turned out to be a short bear market, only lasting a few months.
Still, diversification, which helps limit losses in rocky times, usually works for the patient investor who is a long-term player, especially younger or middle-aged investors, with a long investing time line. Indeed, for the young investor, with 30 years or so in front of him or her, a bear market at the outset would be good. You would be buying a lot of shares at discounted prices that would later be big winners whenever the bull market came roaring back. It will only work if you have a long-term plan. More on that in the next chapter.
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