Jane M. Young, CFP, EA
Build a Portfolio to Support Your Investment Timeframe
Investment timeframe is a major consideration in developing an investment portfolio. Start with an emergency fund covering about four months of expenses in a cash account with immediate access. Next, put aside money that is needed over the next few years into fixed income vehicles such as CDs, bonds or bond funds. Invest long term money into a combination of “stock based” mutual funds and fixed income investments based on your tolerance for investment risk and volatility. Historically, stock has significantly out-performed fixed income investments but can be volatile during shorter timeframes. Stock is a long term investment; avoid putting money needed within the next five years in the stock market.
Diversify, Diversify, Diversify
Once your emergency fund is established and funds have been put away for short term needs, it’s time to create a well-diversified investment portfolio. We cannot predict the next hot asset class but we can create a portfolio that will capitalize on asset categories that are doing well and buffer you from holding too much in asset categories that are lagging. Think of the pistons in a car, as the value of one asset is increasing the other may be falling. Ideally, the goal of a well-diversified portfolio is to have assets that move in opposite directions, to reduce volatility, while following a long term upward trend. It is advisable to diversify based on the type of asset, investment objective, company size, location and tax considerations.
Avoid Emotional Decisions and Market Timing
The best laid plans are worthless if we succumb to our emotions and overreact to short term economic news. Forecasting the short-term movement of the stock market and trying to time the market is fruitless. We can’t control or predict how the stock market will perform but we can establish a defensive position to deal with a variety of outcomes. This is accomplished by maintaining a well-diversified portfolio that supports our goals and investment time horizon.
The stock market can trigger our emotions of fear and greed. When things are going well and stock prices are high we become exuberant and want a piece of the action. When things are bad and stock prices are low we become discouraged and want to get out before we lose it all. The stock market is counterintuitive, generally the best time to buy is when the market is low and we feel disillusioned and the best time to sell is when the market is riding high and we feel optimistic. We need to fight the natural inclination to make financial decisions based on emotions. Don’t let short term changes in current events drive your long term investment decisions.
No one knows what the future holds so focus on what you can control. Three steps toward this goal are to create a portfolio that meets your investment time horizon, create and maintain a diversified portfolio and avoid emotional decisions and market timing.