Investing is the best way to build wealth and outpace inflation. But how do you do it? Many have tried to time the market, but history tells us this is not the best method. Instead, a much more sustainable and efficient manner of getting started is to construct a well-diversified portfolio that is suitable, given your risk tolerance and time horizon.
Equity to Bond Split
The first step to constructing a diversified portfolio is deciding on how much to have invested in equities and how much to have invested in bonds. An equity investment (money invested by purchasing shares of a publicly-traded company) has higher expected returns than a bond investment (a loan agreement made between a government or corporation and investor where a corporation takes a loan and pays it back with interest over time). If you are younger, time is on your side, so you can “afford” to handle market volatility and downturns, which means that a higher percentage of the portfolio could be allocated to equities. If you are older, closer to retirement, or already retired, then a higher percentage of the portfolio should be allocated to safer bonds for risk management.
Diversify Within Asset Classes
Once you figure out your equity to bond allocation based on your investment objective and risk tolerance, you need to look at diversification. It is essential to construct a well-diversified portfolio across different asset classes (groupings of investments that exhibit similar characteristics). Various markets flourish at different times, which is why you want to avoid having your portfolio concentrated in one industry or company. If you “put too many eggs in one basket,” you risk suffering significant losses should the investments fail. A diversified investment approach encompasses global markets, securing domestic and international returns. Stock markets are impossible to predict, with no observable pattern on which industries will perform the best in any given year. This uncertainty makes diversification even more important, as it helps to take the guesswork out of investing.
Long Term Approach
Now that you have a diversified portfolio that is properly allocated, you should leave it alone and let it do the work! You want a disciplined, long-term approach. Try not to fall into the market timing trap by letting your emotions drive your investment decisions during short-term market volatility. It does not work! Many studies have shown missing only a few days of strong returns can drastically impact your overall portfolio performance. As tempting as it can be to make tactical changes to your portfolio, it is imperative to stay the course and not react to market dips and swings.
Overall, to construct a well-balanced investment portfolio, determine your split between stocks and bonds, diversify your investments by asset classes, and practice discipline by focusing on a long-term investment approach. Continually review and adjust your portfolio based on your current financial situation to make the most effective decisions.
McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.
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