Diversification, patience, and consistency are the key components when reviewing your investment strategy. Reviewing your investment strategy through scenario-based financial planning provides the guidance and clarity needed to make a more informed decision.
Diversification. “Don’t put all your eggs in one basket” has some application to investing. Over time, certain asset classes may perform better than others. If your assets are mostly held in one kind of investment, you could find yourself under a bit of pressure if that asset class experiences some volatility.
Keep in mind that diversification is an approach to help manage investment risk. It does not eliminate the risk of loss if an investment sees a decline in price. Be cognizant of Diversification Error. Diversification Error is when investors diversify across all the options available. This error is often made by 401(k) participants who select all the options in the plan line-up and investors who purchase multiple investment funds in the same asset class.
Asset allocation strategies are also used in portfolio management. When financial professionals ask you questions about your goals, time horizon, risk capacity, and risk tolerance, they get a better idea about what asset classes may be appropriate for your situation. But like diversification, asset allocation is an approach to help manage investment risk. It does not eliminate the risk of loss if an investment sees a decline in price.
Patience. Impatient investors can get too focused on the day-to-day doings of the financial markets. They can be looking for short-sighted opportunities rather than longer-term potential. Focusing on short-sighted opportunities can lead to investment decisions based on emotions, biases, or incorrect information, which can lead to poor performance. The cost of a short-sighted mistake is often too great for retirees who don’t have additional working years to try to recoup the loss. Investors with retirement goals that are many years or decades away have time to recover from short-sighted mistakes. However, mistakes from repeat short-sighted behavior can seriously impact the portfolio of any investor, no matter the horizon.
A patient investor knows that markets have periods of fluctuation and has a portfolio that fits their investment profile, comprised of their time horizon, risk capacity, and risk tolerance. Understanding how your asset allocation fits your investment profile is the key to staying patient in turbulent times and avoiding making costly, short-sighted, mistakes.
Consistency. The foundation of every disciplined investor is built on consistency. Consistency in investing requires a behavioral commitment to your investment strategy paired with predetermined periodic contributions.
Investing on a consistent basis is one of the most effective ways to build long-term wealth. This is a strategy known as dollar-cost-average, where you invest a fixed amount of money on a regular basis, regardless of market conditions. To effectively employ a dollar-cost-average strategy, investors need to determine their risk profile, investment strategy, contribution schedule, and contributions as a dollar amount or percentage.
401(k) contributions can be a great example of consistency. Plan participants select the investments from the available options that best fit their risk profile and investment strategy. Next, they determine the amount they would like to contribute per pay period. Those who select a percentage of their salary see the dollar amount increase as their salary increases, helping to reach the maximum annual contribution limits.
Decision-Making with Scenario-based Financial Planning
It is easy to grasp the concepts of diversification, patience, and consistency but implementation can add a layer of complexity. Utilizing a scenario-based financial plan adds clarity to your decision-making and investment strategy.
Scenario-based planning accounts for inherent future uncertainties by quantifying the financial implications of change and analyzing a range of possible outcomes.
Through scenario-based planning, we illustrate the potential impact various scenarios can have on your portfolio and your retirement needs. For example, illustrating the impact of a bear market on your retirement savings, based on your current investment strategy. From there, we can stress-test alternative investment strategies against the same set of variables.
At RMR, we create financial plans with three primary objectives; Organize, Educate, and Guide. A scenario-based financial plan that addresses your investment strategy can guide you on the path to improving your chances of a safe and secure retirement. Our process helps you make a more educated decision when selecting what investment strategy best fits your risk profile.
Reach out to our team if you are interested in creating your financial plan or want to learn more about our pricing options.
Below is an example of the decision center being used to illustrate the pitfalls of the current investment plan versus the potential of an alternative investment plan.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG, LLC, is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright FMG Suite.