In Long-Term Investment Truths Part 2, we aim to highlight some of the strategic aspects long-term investors should consider. While there are several aspects to consider when investing for the long-term, we’ve limited the scope of this letter to some of the most common items we’ve seen investors overlook.
Long-Term Investment Truths: Part II
• Utilize Asset Allocation – Asset allocation is the weighting of equities (stocks) versus fixed income (bonds and other debt instruments) in your investment portfolio. The mix of equities and fixed income is often fluid as market conditions and withdrawals shift the weightings between the two primary asset classes over time. For instance, when equities grow faster than other asset classes, such as fixed income, they can quickly account for a larger percentage of your investments. Correspondingly, your allocation to fixed income may shrink as a percentage of your portfolio.
The closer you are to retirement, the more important the mix between these two asset classes becomes if you need to withdraw from your portfolio for spending needs. Having too much in equities may over-expose you to potential market volatility, possibly forcing you to sell assets at less than favorable prices, or worse, at a loss. Inversely, having too much in fixed income may over-expose you to inflation risk, where the increase in cost of living outpaces the returns on your portfolio. The weighting between equities and fixed income should align with your financial needs as improper asset allocation may increase the likelihood of you outliving your money.
• Consider Value-Oriented Strategies to Manage Risk – For the long-term investor, risk should be thought of as the probability of permanent loss rather than price volatility. That probability is increased when you pay a significant premium above what a stock is worth. A good way to manage risk over time may be a value-oriented investment strategy. This strategy aims to reduce the likelihood of overpaying for a stock by estimating its intrinsic value, or what the underlying business is worth versus its market price. For the long-term investor, the strategy may improve return potential, which can lead to greater financial security. Combined with proper asset allocation, a value approach can also be, in our opinion, one of the best ways to manage risk.
• Understand Familiarity Bias – Sometimes an investor will succumb to familiarity bias, which is the tendency to be over-reliant on familiar investments. Furthermore, this over-reliance can lead to a lack of diversification in an investment portfolio. This is particularly true when investors accumulate large holdings in their employer’s stock as part of their compensation plan.
• Insufficient Diversification – With insufficient diversification in a portfolio, over-reliance on a particular sector or company to perform can exert a measurable influence on the overall portfolio performance and put your financial well-being at risk. We commonly see this dilemma with energy professionals, where they may be significantly over exposed to the energy sector. If this sector goes through a rough patch, this type of investor stands to suffer greater losses than someone with a more diversified portfolio.
• Liquidity Matters – The older you get, the more important being able to quickly access your money becomes. Family emergencies, early retirement, or other unforeseen circumstances may require you to tap into your savings sooner than anticipated. If you have a fair amount of your savings in illiquid long-term investments such as real estate and collectibles, you may have a problem – those dollars may be “locked up” or inaccessible without paying excessive fees, commissions or penalties. Some investments can be harder to liquidate than others as they may be thinly traded, out of favor, or administratively complex, such as master limited partnerships (MLPs) and some real estate investment trusts (REITs). Insufficient liquidity can lead to unintended consequences such as having to sell other types of more liquid investments, which may have grater return potential, in order to meet short-term financial obligations.
The aspects above should never be overlooked, as doing so could lead to significant problems down the road. It is important to take steps now to make sure that your portfolio is properly aligned with your financial needs and goals as these problems often become harder to fix over time.
About The Goff Financial Group: As a fully independent Registered Investment Advisor, the Goff Financial Group is not owned or controlled by any bank, brokerage firm, mutual fund company or any other company. The company does not receive any fees or commissions from any financial products and works solely for its clients on a fee-only basis. Disclaimer: This material was prepared using third party resources, and does not necessarily represent the current views of The Goff Financial Group which are subject to change without notice. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering tax or legal advice. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as financial, investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This document is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.