Many investors have a dark, ugly secret – they don’t have an investment plan for their portfolio. Their portfolios are often a semi-random collection of stocks, ETFs, and mutual funds purchased over a long period of time. While markets are going up, as they have for much of the last 10 years, these randomly selected securities tend to do well. It is only when markets go down substantially, as they did at the end of 2018, that investors start to review what is in their portfolio. Often, the portfolio holdings are concentrated in areas that have outperformed, for example, tech stocks. We all feel like geniuses when our portfolios go up, but many of us panic when they start to drop dramatically.
Every portfolio should have a plan or strategy that determines its holdings. The biggest reason to have a plan is to ensure that we do not panic when the market has its periodic pullbacks. Many investor portfolios perform substantially worse than market benchmarks. The reason is we succumb to the emotions of greed and fear. When the market is going up, we want to buy stocks that have done better than the market. However, when the bottom starts to fall out of the market, investors panic and sell the good with the bad. In essence, we buy high and sell low. Then, once we’ve sold, we don’t buy again until the market has risen substantially.
An investment plan determines expected levels for gains and, more importantly, acceptable levels for losses. Based on these levels, the portfolio risk, usually determined by its percentage allocated to (equities) stocks, can be determined. For example, if the market goes down 30%, a portfolio that is 50% allocated to stocks and 50% to bonds may only go down 15% or less. Even if you started with an investment plan, many times, after a long period of good market performance, portfolio allocations can become more heavily allocated to what has gone up the most — stocks. This results in greater risk in the portfolio unless it is rebalanced to the original allocation on a regular basis. For example, suppose 10 years ago you had invested in a portfolio that was 60% stocks (SPY – S&P 500 ETF) and 40% bonds (AGG – US Aggregate Bond ETF). Today, that same portfolio would have a 75% allocation to stocks and only a 25% allocation to bonds. The portfolio risk level is substantially higher than its original target.
With the bull market now over 10 years old and stocks at record levels, it is more important than ever to understand what is in your portfolio and make sure you have an investment plan. If you would like to discuss creating an investment plan for your portfolio, feel free to contact us at info@L2Wealth.com.
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