Stocks provide superior returns over the long term but they come with an emotional roller-coaster ride. The convention is to add bonds and cash until portfolio returns are smoothed down to the investor’s comfort level.
A better solution may be to concentrate on stocks and develop the appropriate mindset for coping with stock-market volatility.
If an investor has a tolerance for the ups and downs of an all-stock portfolio, there is no need to dilute the superior returns of stocks, especially when yields are so low on bonds and cash. An investor who has psychological fortitude is also less likely to flee at market bottoms. Those with balanced portfolios laid over untutored risk tolerances are more vulnerable.
The experience of hanging in over several market cycles is one way to acquire resilience. The other, in the case of less seasoned investors, is mental preparation.
This involves becoming familiar with the charts showing how stocks have downturns but always rebound to higher levels. Another step is reading books on behavioural finance (such as Jason Zweig’s, Your Money & Your Brain), to become aware of the psychological pitfalls. And it helps to have a long-term view rather than heed short-term fluctuations.
A more advanced method is visualization techniques. Imagine in detail a re-occurrence of episodes like the crashes of 2002 and 2008, and rehearse the actions you’ll take (like staying busy with home and work projects to wait it out). The more vivid the visualization, the more effective it will be – so soak up stock-market history to get the details.
And so on – there are a several ways to inculcate the right perspective. If you have it, and a long enough time horizon, you can do better than investors saddled with balanced portfolios.
READERS: What do you think is more important? A balance of asset types in your portfolio, or the mental fortitude necessary to ride out events?