Human emotions can deter a long-term investment strategy
Having a strategic asset allocation plan in place that is customized to your particular financial objectives, investment timeframe and tolerance for risk is essential for individual investors. By allocating assets across a variety of asset classes (Exs. U.S. Equities, International Equities, Bonds, Commodities, Cash, etc…), and by taking advantage of how those classes correlate, I believe individual investors can typically experience better and more consistent long-term performance than by concentrating risk in narrow sectors or specific asset classes. This belief is supported by the landmark 1986 study entitled “Determinations of Portfolio Performance”, and updated in 1991, of 91 large pension funds by Gary Brinson, Randolph Hood and Gilbert Beebower that concluded that, on average, that more than 91% of the variation in portfolio performance could be attributed to the portfolio’s asset allocation – many times greater than the selection and timing of individual security transactions.
Yet, when markets stumble and investors get fearful, as they both did in 2008 and continue to in 2009, individual investors tend to exit their long-term strategies abruptly and in great numbers. In so doing, they essentially lock in their losses and potentially prevent themselves from fully participating in any future recovery. Individual investors should be honest with themselves and their financial advisors when putting together an asset allocation strategy to meet their own unique set of circumstances. When markets are rising, investors tend to become overly tolerant of risk and when markets are falling, investors tend to become overly risk averse. This human tendency is negative for long term investment performance. Investors need to understand what their overall tolerance for risk is regardless of whether the market is going up or down. If they have been completely honest and the financial advisor has the means by which to build an appropriate asset allocation strategy, then investors should sleep well at night knowing that they have a plan that was constructed, and is periodically re-balanced and re-positioned as necessary, to help guide them towards their financial goals.