Despite the difficulty markets that appear during economic cycles, the greatest danger for long-term investors is not experiencing financial loss, but rather not having enough. That’s why maintaining a diversified portfolio is essential. While there is no guaranteed solution, there are three straightforward and effective investment strategies that can help.
1. Avoid Extremes
There is a growing number of investors who believe they should focus their portfolios on a few large technology stocks, especially due to their strong performance during the COVID-19 pandemic. This approach can lead to over-concentration, as the thrill of making a correct market prediction can be addictive. However, this method is not sustainable as no stock or sector consistently outperforms the market. At some point, something else will replace the performance of technology stocks, and it is impossible to predict what that will be.
Therefore, it is crucial to maintain diversification, even if it may not seem as rewarding in the short term. This approach ensures stability and reduces the risk of tragedy. For those who still want to take market risks, planners suggest setting up a separate, smaller “fun portfolio” in a self-directed account. This allows investors to experiment with market timing without putting all their assets at risk. By doing this, they can satisfy their urge for risk-taking while ensuring most of their assets are in well-diversified portfolios.
2. Be Wary of Cash
During uncertain times, some investors may be tempted to abandon their investment portfolios and turn to cash. Although the recent global pandemic and mounting geopolitical tensions are understandable reasons for caution, holding too much cash can have negative consequences.
A reliance on cash often creates a vicious cycle, where investors wait for market corrections and miss out on gains. Historically, those who became overly reliant on cash during market downturns in 2000, 2008, or in 2020, missed out on significant growth opportunities. While hindsight makes it seem easy to invest during these times, it’s never clear in the moment.
3. Be Prepared and Avoid Predictions
The art of investing involves more preparation than prediction. It is nearly impossible to predict the future accurately, which is why preparation is crucial. By conducting a “pre-mortem” analysis of their portfolios, investors, with the help of skilled planners, can anticipate potential challenges and develop a plan of action. For instance, if tech stocks were to suddenly drop 25%, investors would know whether to buy more shares or sell their positions, rather than allowing emotions to dictate their decisions. Preparing in advance leads to better outcomes over time.