At the start of each new year, many of us make resolutions to improve our lifestyles. It’s a natural time to take stock of the past year and look to make some beneficial changes for the future. Tops on most lists are shedding pounds, getting fit, quitting bad habits, or learning something new.
In this spirit I’ve come up with my top 4 investment resolutions for 2011.
1) Ignore economic forecasts
We are constantly bombarded with contradictory economic predictions. Markets are forward looking and incorporate all known information into a security’s price. Generally good economic news, such as we see now, has already been incorporated into prices. Therefore, only surprises matter to the markets. Good surprises and bad surprises are the biggest drivers of security prices. The surprising information is instantly reflected in the next day’s prices. By definition, surprises cannot be forecasted, making it impossible to make bets that pay off ahead of time.
2) Keep bonds in your portfolio
I’ve recently fielded many calls from clients who are worried about predictions that bonds are poised for collapse. Bonds have outperformed stocks over the past ten years, which is unusual but not unprecedented. As interest rates rise, the value of your bond holdings will go down. However, over the long run, bond returns are predominantly determined by the interest payments generated from holding the bond. Additionally, the primary reason to hold bonds is to reduce risk in the overall portfolio that includes much riskier stocks.
3) Revisit your asset allocation
The new year is also a good time to review your investment plan. Ask yourself a few important questions: Have my long-term financial goals changed? Is my time horizon different? Has my ability, willingness or need to take risk changed? If you answered yes to one of these questions, then it may be appropriate to revisit your current asset allocation. Making changes to a portfolio based on short-term market disruption is almost always a bad idea. However, reallocating your portfolio based on rational changes to your situation should be done at any time the need arises.
4) Control the controllable, ignore the rest
It’s easy to say, but hard to do. The highest probability of investment success comes from 3 important factors:
• Understand Risk: Determining asset allocation based exclusively on your need, willingness and ability to take risk.
• Control Costs: The use of low-cost passively managed mutual funds that match the return of the various markets will result in more money in your pocket at the end of the day.
• Diversify: Incorporating various asset classes into an investment plan reduces overall portfolio risk for a given level of expected return.
The value of an investment advisor is to help you understand these factors for investment success and provide the discipline to carry out the plan, often in opposition to conventional wisdom.