As we pass the 15-year anniversary of the “Financial Crisis”, which marked the USA’s significant market decline that most of us have experienced, we think back on the lessons learned during tough times as we continue to apply those principles today. Here are a few lessons for those who are new to investing and may not have their own firsthand experience to look back on as markets turn volatile.
Lesson 1: Decide on an asset allocation upfront, and stick with it
When we construct an investment strategy for a client, it includes a deep understanding of our client’s wealth goals, or their finish line. The strategy also considers our client’s tolerance to emotionally accept the expected volatility of the portfolio, during both good and challenging market cycles. We find this disciplined approach to individual portfolio construction helps to eliminate some emotional aspects of investing, which can result in poor performance.
When there is uncertainty in the market, volatility typically increases. Most often the volatility is short-lived and changes to allocation and risk is unnecessary. But if a well understood strategy is not in place, an investor may react by changing risk at the exact wrong time.
To avoid a pitfall like that, taking steps to understand the cause of the volatility and identifying ways to mitigate risk or take advantage of market opportunities is a much better strategy.
Long-term success in investing is accomplished with primarily subtle moves which support a thoughtfully prepared strategy.
Lesson 2: Diversify assets and Avoid lagging investments
The financial crisis highlighted the importance of diversifying your assets to mitigate risk. For example, investment portfolios that were heavily weighted in financial company stocks during this time took a more substantial downturn than a portfolio invested across multiple sectors and markets. This larger decline in financials was the result of a slowing economy, a credit crunch, and problems with mortgage assets which these financial companies held. By distributing assets among many different asset classes, regions, sectors and styles, while also being willing to avoid unfavorable investments entirely, an investor can reduce unsystematic risk and avoid unnecessary volatility.
Lesson 3: Keep line of communication open
As with all successful relationships, communication is the key. And especially when times are uncertain. We have found that delivering honest and realistic market outlooks to our clients has helped them avoid emotional decisions that could be detrimental to long term success. Open lines for communication also allows clients to voice their concerns and perhaps communicate changes in their life that may need adjustments to portfolio risk.
It is important to have open and honest communication with your advisor before times of uncertainty and heightened market volatility. This allows you to build a solid strategy to meet your wealth needs and keep you on track if, and when, the markets get rough.