OCEAN CITY — The following five common investing myths, when put into full context, can prove key reminders as investors seek to achieve their financial goals.
Myth #1: “I should wait for a pullback in markets before I get invested.”
Reality: Investors need to stay invested in order to achieve their long-term financial goals. Market timing is often a losing strategy.
Equities are almost always part of an investor’s goals-based asset allocation and therefore the tendency to time the markets using equities is a common tack. U.S. equity markets are trading near all-time highs, and valuations are no longer cheap. Some investors may be tempted to sit on the sidelines before allocating capital. This may be imprudent and ultimately quite costly. Instead, it is advisable to remain invested according to one’s goals-based allocation and look for tactical opportunities that can add to performance.
Myth #2: “The market has done very well lately; shouldn’t I let my winners continue to win?”
Reality: Rebalancing helps reduce risk and smooths investment returns.
Diversification is a key tenet in portfolio management that helps target an investor’s risk tolerance, and rebalancing is important in maintaining a particular risk tolerance. A disciplined approach to rebalancing can help manage a consistent level of portfolio risk. Through both portfolio rebalancing and dollar-cost averaging, investors can avoid getting stuck with poor market timing and better control risk
within a portfolio.
Investors devote time to creating a financial plan that reflects their goals but often tend to overlook the periodic rebalancing of their portfolios and having a disciplined plan in place to do so. Incorporating a regular rebalancing plan imposes a discipline to buy low and sell high. Research shows that most investors, driven by various degrees of greed and fear, tend to do the opposite.
Myth #3: “Volatility is detrimental to my portfolio.”
Reality: Volatility is part and parcel of taking risk in capital markets; investors should be more concerned with permanent loss of capital that is always detrimental to a portfolio.
Investing in financial markets involves taking risk. Volatility is the most common definition of risk, which measures the degree to which asset prices can fluctuate around their average return. During periods of financial market stress, asset prices tend to decline and volatility tends to spike. As investors participate in capital markets with a particular goal in mind, there is a relationship between the amount of return an investor is looking to achieve and the risk of the portfolio. Typically, a higher desired return target is accompanied by a greater level of risk, and vice versa.
Myth #4: “A diversified portfolio consists of stocks, bonds and cash.”
Reality: Alternative Investments, where suitable, offer an expanded set of opportunities with a different set of
risks that can help diversify a traditional stock, bond and cash portfolio.
Traditional asset classes such as stocks, bonds and cash have performed well over the last six years, and investors who have stayed invested in them have been rewarded. However, returns from traditional asset classes are likely to be more moderate going forward, accompanied with greater volatility. We see an opportunity to expand beyond the traditional asset classes and, where suitable, into alternatives, which offer exposure to less liquid and more concentrated set of exposures. Where
suitable, we believe Alternative Investments (AI) can help.
Myth #5: “I need high-yielding securities in order to meet my investment income objectives.”
Reality: Focusing on total portfolio return and diversifying sources of income is a prudent approach to generating portfolio income.
Most investors view income as purely cash flows from dividends and interest from their investments. In today’s low-yield environment, investors relying excessively on cash flows are squeezing their bond portfolios harder than ever for that last bit of current income, and as a result venturing into riskier areas they normally might not consider. A diversified approach to income can help mitigate some of these risks.
We favor a more robust approach to income by focusing on portfolio total returns. Investors should consider multiple sources of portfolio income: bond coupons, stock dividends, financial strategies and capital growth. Individually, each source offers some degree of cash flow and opportunity for capital appreciation, and poses some risks from liquidity, volatility and growth.
(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)