I am often asked which one is my favourite. I don’t actually have a favourite – to me they are all equally important. I think it is worth exploring each one, but taken together these points are a great foundation for any long-term financial plan.
Your asset allocation explains most of your returns
Your asset allocation specifies the proportion of your portfolio invested in various asset classes like stocks, bonds or alternatives. It helps to balance the risk and return in your portfolio, anchoring it through different business and investment cycles, and is a key driver of your long-term investment performance. Asset allocation is often the single most important decision you will make as an investor. You need to get this part right.
Diversification is your most important investment strategy
Different asset classes go up and down at different times, so taking a diversified approach to your investments can help a lot during periods of volatility. A well-diversified portfolio should lead to smoother, more consistent returns. This will likely help you stay invested over the long-term versus selling your investments in volatile times.
Broaden your investment universe to find opportunities
As investors, you want to take advantage of all of the opportunities that are available to you. The more options that you look at, the greater your ability to diversify. By taking a global approach and looking at investments outside of the concentrated Canadian market, you tap into the other 97% of the world’s available investment opportunities. This improves diversification, which should ultimately lead to a smoother investment experience (see my previous point).
Market uncertainty never goes away
The one thing we know for sure is that the future is uncertain. This uncertainty often scares investors away from markets or into trying to time them. The key to investment success is not to try and predict the future. Rather, it’s about building well-diversified and resilient portfolios that can weather the storm no matter what market environment we are in.
Higher returns come with higher risks
Risk is fundamental to investing. No discussion of investment returns or performance is meaningful without also considering the level of risk involved. If you want the potential to earn a higher return on your investments, then you have to be willing to accept more risk or volatility (think swings in the value of your investments). But investing success isn’t always about chasing higher returns by maximizing risk – it’s about finding the right balance between risk and return that works for you. If your tolerance for risk is low, then you’ll have to give up some return in order to achieve that. As the old saying goes, you can’t have your cake and eat it too.
It’s time in the market, not timing the market
In a previous article, I mentioned that it’s time in the market, not timing the market that leads to investment success. Investors trying to time the market need to make two correct decisions – when to get out, and when to get back in. Even if you manage to find the right time to get out of the market, it’s highly unlikely that you will get back in at the right time. This will have an impact on your results. Take 2019 as an example. If you became nervous during the volatile period at the end of the 2018 and moved to cash, then you missed out on some impressive returns during 2019. Sitting on the sidelines and missing some of the strongest days in the market can have an impact on your investment returns.
The cost of missing the best day in markets