Between ISIS and Ebola, it seems like the world is in crisis. How can you prepare your investment portfolio to withstand anything?
Between ISIS, the Ebola outbreak, Russia in the Ukraine and a persistently weak Europe, it might sometimes feel like the worlds, and your portfolio, are in constant peril. Especially after the financial crisis, where most investors experienced the fear and market drops firsthand, looming problems around the world can feel just as unpredictable and unmanageable.
But you don't need to worry: you can take action to prepare your investment portfolio to withstand any crisis without resorting to putting money under the mattress.
It's been said time and time again, but that's because it's true: the best way to avoid overexposure to a particular risk is to diversify. It's a strategy that works just as well for geopolitical risks and economic crises as it does for companies and mutual funds.
Not convinced? Consider this: Russell Investments tracked the best- and worst-performing asset classes for rolling 10 year periods between 2003 and 2013. Which asset classes do you think performed the best?
As you can see, the results are all over the place. It goes to show you that despite how things might seem in a given moment, it's actually very hard to predict which asset classes are going to perform better or worse and how a particular crisis is going to affect the markets.
In other words, to protect yourself from the decade's worst-performing asset class, your best bet is to diversify.
How do you diversify? As you can see from the chart, investing isn't just about American stocks and bonds. Diversification can and should go across geographies and asset classes to the extent they line up with your objectives and time horizon.
Of course, you might think that maintaining exposure to an investment that's affected by a crisis still puts you at risk, and you're right: there is always some risk when you're investing, no matter what the asset class.
But remember: it's pretty much impossible to predict what's going to happen in a particular market or asset class at a particular time, and you'll usually do far more harm than good for your portfolio if you try to make these predictions. After all, by moving in and out of holdings based on the news, you'll be trading alongside other nervous investors and you'll be forced to sell at far worse prices as a result.
For example, consider that in 2008, emerging markets were the worst-performing asset class, with a return of -55.5% according to Russell Investments. If you had decided that this was too much and sold out, you would have turned a paper loss into a financial one and you would have missed out on the following year's comeback, when emerging markets returned 83.8%.
In other words, by trying to only hold top-performing investments or those that you feel don?t pose an immediate risk, you'll be taking away the benefits of diversification and, unfortunately, shooting yourself in the foot.
By trading in and out of positions, you are also exposing your portfolio to one of the biggest performance-killers there is: transaction costs. Your trading fees might seem small, but they really add up over time and have a persistently negative effect on your overall returns one that could have a far more detrimental effect than any particular crisis.
So, expose your portfolio to a diverse range of investment options, and keep them well-balanced and in line with your goals and objectives. Instead of letting the news affect how you allocate your investments, be guided by your plan. It takes extraordinary discipline to stick with this strategy, but it really does pay off in the end.
The trouble with investing in this way is that it takes a lot of discipline and a firm level of control over your emotions. That can be really hard to manage in the moment, and that's okay. After all, your investments aren't just assets, they probably reflect your hopes, dreams, and ambitions for the future. Those just aren't unemotional topics for most people. Using a professional to keep you disciplined can often be a wise decision.
So, if you find yourself worrying about crises or wondering how to manage them with respect to your investments, consider getting professional financial advice. A great financial advisor will not only help you navigate the universe of investment options, but he or she will also provide the invaluable service of helping you to stick with your strategy.
How does it work? Once you've established your risk tolerance and time horizon, a great advisor will help you put together a portfolio that is appropriately diversified. Depending on your arrangement, he or she will also check in and rebalance the portfolio periodically to make sure it's still in line with your long-term goals. This helps to prevent you from getting too much exposure to a particular asset class or too little exposure to another.
Your advisor will also be on call for questions and to ensure that you feel confident and knowledgeable about your strategy. If you're worried about the Ebola outbreak or how the news in the Middle East might affect you, you'll have someone to call who can help you to ensure that your portfolio is set up to manage the wide range of risks we face in the world.
And for many people, that peace of mind is the most invaluable service of all.
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