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Back to Basics
Part I: To Rediscover Goals, Be Honest With Yourself
Editor's Note: The first bear market in several years has caused many investors to ask: "How did I go astray?" The answers often include one or more decisions that ignored the most basic ideas for pursuing investment success. That makes this a good time to review those basic ideas, along with the reasons why they work in both up and down markets. This is the first article in a three-part "Back to Investment Basics" series.
Why Rediscover Goals?
Has the past year been hard on your portfolio? Are you looking at today's investment news and wondering what you should do to cope with a bear market and uncertain economy?
If so, I urge you to take a deep breath and step back from all that. At best, day-to-day financial events are a big distraction for most individual investors. At worst, reacting to them in times of uncertainty and stress may cause you even more difficulty down the road.
Instead, take this opportunity to be honest with yourself and rediscover your goals. That's where most successful investment programs begin.
Goal rediscovery is a valuable exercise that will remind you why people become investors in the first place. The primary purpose of your investment program should be the long-term accumulatation of money for a projected point in the future, so that you can meet specific goals that define your lifestyle and personal success. These goals may include sending children to college, retiring with the financial ability to travel around the world, or having enough money to support yourself in old age. They involve basic human needs and aspirations — not quarterly rates of return.
Why You Should Be Honest and Realistic
In the most fundamental sense, investing is about using today's resources prudently to achieve future goals. It's also about being honest with yourself and keeping your planning simple. Defining your goals clearly is far more critical than any amount of daily investment chatter you hear on CNBC, or all the financial marketing hype that bombards your attention span and complicates your life.
How do you rediscover major goals? If you have children to educate, you might want to focus on how much college is costing these days, not the daily stock market tables. This is also a good time to recast planning assumptions, perhaps using a more conservative investment rate of return than you believed possible in the middle of the big bull market. Evaluate how you can achieve your goals at a historically realistic return, within your risk tolerance. The assistance of a financial professional skilled in long-term planning can be valuable in this process.
A planning exercise focused on defining goals sets the stage for all specific investment decisions that will follow. It prepares you for a proven investment process that gives you the greatest probability of achieving your goals, and that is asset allocation. Followed consistently, proper asset allocation can help you avoid pitfalls that are detrimental to your success, such as reaching for the hottest stock or highest performing fund manager. This process has a built-in discipline that recognizes and respects the inherent risks of financial markets. When markets overheat with speculation, this process can prevent you from following the herd into higher risk exposure. In times of uncertainty, you won't have to think or decide too much, because the process will guide you through.
The Value of Long-Term Perspective
When you rediscover important goals, you regain perspective on how long your lifetime may be and how critical long-term perspective is to goal achievement. If your goal is to acquire enough assets to retire 16 years from now, does it really matter so much if the markets take a dip in year 10? A long-term perspective helps you enjoy one of the most powerful historical trends of the markets — their tendency to "smooth out" short-term volatility over time.
When your assets are well diversified in an asset allocation program with a long-term horizon, you can afford to assume some short-term risk. History has shown that most bear markets have not lasted more than a year or two. If you hold on through the worst times, you will have opportunity to participate in the bounce-backs that have always followed. In addition, you will avoid the classic behavior that harms so many individual investors at the bottom of every cycle — namely, they panic and sell out. This locks in their losses and removes them from participation. When more rewarding markets return, they are left behind.
Human Nature Holds a Contradiction
In rediscovering your goals, recognize that human nature holds a contradiction in regard to investing. It's your basic nature to want the euphoria of a short-term positive performance hit. Also, it's human nature to fear the consequences of bad returns, which may influence the realization of your long-term goals. It is this contradiction that must be honestly addressed because it determines your asset allocation; it determines what investments you hold. In short, getting the balance right determines the success of your long-term investment plan.
When you are capable of defining and pursuing your goals in a long-term process that helps you remain cautious through the tops of markets and confident through the bottoms, then you have taken perhaps the first important step in getting "back to basics."
Copyright © Russell Investments Canada Limited 2008. All rights reserved. See Important Legal Information. Date of first use: 05/16/01.
Past performance is not a guarantee of future performance.
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Russell Investments Canada Limited.
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