Lessons from the Past | The Value of Asset Class Diversification
During the past 26 years, I’ve had the opportunity to guide my clients through 3 major market events and hundreds of smaller downturns. Now that our financial markets, for the moment, have recovered from the most recent events we encountered this year, I thought it would be prudent to review a few fundamental theories to keep in mind when the next market event arises.
Market declines are common and temporary occurrences. Market declines can cause imprudent behavior by filling investors with dread and panic. The review is to realize that although market declines are inevitable, they do not last forever. In addition, they are a normal part of the investment cycle. The second theory to keep in mind is maintaining a proper perspective. Studies have shown that people place too much emphasis on recent market events and disregard long-term realities. Sensational news headlines are meant to grab our attention, but it can be dangerous to let headlines influence our investment decisions. The review is to ignore the noise, stay focused on our long-term goals, and our long-term objectives.
Our third theory to keep in mind is to not try and time the market. Studies have shown that losses feel twice and bad as gains feel good. We remember losses more than our gains. Keep in mind that fleeing the market to reduce losses could mean losing out on gains when markets recover. Emotions also play a big part in trying to time the markets. We’ve all heard the adage, “buy low, sell high”. However strong emotions can tempt us to do the opposite. We may also feel that doing something-anything-during a downturn is better than doing nothing. Although inaction might seem counterintuitive, staying invested on our course could be the better choice. No one knows the perfect times to get in and out of the markets. The review is to stay focused on your long-term goals and carefully consider your options. My fourth and final review theory is to maintain a diversified portfolio. Simply put, different investments may go up and down at different times. Spreading your portfolio among different asset classes and investments with different risk parameters will help reduce volatility in your overall portfolio.
I hope this review has helped. I will finish it by quoting Warren Buffet. Buffet maintains that “the stock market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” Here’s to patience during the next major market downturn!!!