How to Feel About Consumer Feelings
The Consumer Sentiment Index is sometimes viewed as a beacon of how investors feel about the direction of the economy.
In the first installment of our Young Investor’s Guide to Building a Financial Future, we looked at avoiding credit card debt to set you off to a healthy start, the benefits of investing over the long term, and the advantages of doing so in a retirement account such as a 401(k) or IRA.
In the second part of this two-part series, we discuss three more investment concepts every young investor may want to embrace:
In the short term, stock market swings can test even the strongest-willed investor. But over the long term, the market has historically shown a remarkable ability to smooth out performance and head in an upward direction. Holding a diversified basket of many different types of investments helps your portfolio weather short-terms bumps in the market and benefit from the market’s growth over time.
What is diversification? In a general sense, it is about spreading your risks around. In investing, that means it is more than just ensuring you have many holdings. It is also about having many different kinds of holdings.
While this may make intuitive sense, many investors come to us believing they are well-diversified when they are not. They may own a large number of stocks or stock funds across numerous accounts. But upon closer analysis, we find most of their holdings are concentrated in large-company U.S. stocks, or similarly narrow market exposure. Diversification works because different types of investments react differently as market conditions change. When one investment falls on hard times, others might be performing well and can buoy the overall performance of a portfolio. If all of your holdings are too similar in nature, diversification is unable to work its wonders over time.
So how do you get diversified without overcomplicating your life? Invest in one or a few basic index and index-like ETFs and mutual funds. Seek funds that track and hold a broadly diversified basket of stocks similar to those in broad market indexes, such as the S&P 500 or the Russell 2000. Favor those with relatively low expense ratios. (These days, your basic, well-diversified index ETF need not cost you more than a fraction of a basis point.) You can build a well-diversified portfolio with just a handful of these sorts of low-cost holdings.
As your wealth grows, you may decide to add exposure to systemic market factors that have been shown to enhance portfolios over time. For example, as described in this Dimensional Fund Advisors piece, “value” companies have “low relative prices (stock price divided by an accounting metric such as book value).” Over time and in aggregate, such companies have delivered a built-in premium return compared to growth companies. By adding a value fund or ETF (and importantly, holding it over the long run, as described in part one of this series), you can increase the odds of experiencing higher returns over time, if you are also willing to accept a likely wilder ride along the way.
In short: Investing broadly across assets of various sector, size and geographies can help you build a resilient portfolio that can better weather the ups and down of the market over time.
Focusing attention on broad market indices can also help you avoid speculative behaviors that tend to have a negative impact on your long-term returns. These include market timing and stock picking.
Attempts at timing the market, buying and selling stocks based on breaking news and short-term market movements, often turn out poorly. Because you are typically buying into hot trends and selling when conditions are scary, you end up buying when prices are high or selling when prices are low. In both cases, that behavior can take a big bite out of your savings, causing major setbacks as you work toward your long-term financial goals.
In fact, investors’ poor track record around market timing is well known to researchers. A long-running annual survey of investor behavior by DALBAR found that the average equity fund investor trailed the S&P 500 by roughly 5.5% in 2023 due in large part to poor decisions surrounding when to buy and sell.
Meanwhile, stock picking can overload your portfolio with too-few individual securities. This reduces your diversification and introduces something known as concentration risk. Investors are typically rewarded for taking on systematic risk, or risk inherent to the entire market. Concentration risk is not systematic. Rather, it is particular to the stock you hold, and as such, you cannot expect to be consistently rewarded for taking it on.
If you hold a large portion of your portfolio in just a few stocks, each holding can have an outsized effect on your portfolio. Should something happen to just one of the companies you happen to hold (bankruptcy, for instance), you could lose a big chunk of your savings.
It is also exceedingly difficult to pick stocks that will outperform the broader market over time. Consider that in 2023, more than 70% of companies in the S&P 500 Index underperformed the index. These results vary from year to year. But since a handful of companies often drive most of the stock market’s returns, choosing just when to sell the future losers and buy the next big winners can end up becoming an impossible (and often losing) game.
In short: Timing the market can lead you to buy stocks when they are expensive and lock in losses by selling during downturns. When it comes to stock picking, it is exceedingly difficult to pick single stocks that will be winners, and holding concentrated stock positions can introduce uncompensated risk to your portfolio. Instead, build a diversified portfolio as part of your long-term financial plan.
So how should you divvy up your diversified investments? Start with your asset allocation, which is how your portfolio is spread among asset classes including stocks, bonds and cash. Then base your asset allocation on your personal goals, tolerance for risk and the length of time you have to invest.
If you search the internet, you are likely to instead come across various rules of thumb to help you choose how to allocate your funds, such as the “your-age-in-bonds” rule. This rule suggests you hold a percentage of bonds equal to your age. A 30-year-old would supposedly hold 30% of their portfolio in bonds and 70% in stocks, for example.
Be wary of rules of thumb like these. They depend on broad averages, not your individual circumstances. Also, it can be ill-advised to reconfigure your portfolio too frequently or based on something as distracting as whether you are 29 or 31 years old. With years ahead of you, if you are able to remain calm and invested during the market’s inevitable rough patches, a healthy dose of stock market returns can take you far.
In short: Build your portfolio based on your personal goals, risk tolerance and time horizon rather than chasing or fleeing hot or cold investments or focusing on generalized rules of thumb.
This post was written and first distributed by The Writing Company.
DISCLAIMERS
This material is intended for general public use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact one of our financial professionals for guidance and information specific to your individual situation. This is not an offer to buy or sell a security.
Shore Point Advisors is an investment adviser located in Brielle, New Jersey. Shore Point Advisors is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Shore Point Advisors only transacts business in states in which it is properly registered or is excluded or exempted from registration. Insurance products and services are offered through JCL Financial, LLC (“JCL”). Shore Point Advisors and JCL are affiliated entities.
The Consumer Sentiment Index is sometimes viewed as a beacon of how investors feel about the direction of the economy.
What happens when a mutual fund or ETF becomes obsolete? The most common and straightforward outcome is a liquidation.
Another election day has passed. It is hard to know what will happen between now and the inauguration, let alone what awaits us beyond.
Let’s contemplate some of the tried-and-true steps to help better prepare your financial affairs for when disaster strikes.