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ABCs of Portfolio Investing: 3 Rules for Long-Term Investors

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September 13, 2016
Understanding short-term and long-term rules for portfolio investments.

Attention investors: school is back in session! 

It's September. The temperature cools, leaves change colors, and kids load backpacks with books, fresh notebooks, and pencils. The back-to-school rush plays out not just across the school yard. This time of year impacts the business world too and can offer investors a fresh start. 

September offers investors the opportunity to revisit the basics of managing a portfolio. It can be a good time to make portfolio tweaks you may have been considering. 

"With long-term portfolios, sometimes investors set it and forget it, but that can lead to bad things," says JJ Kinahan chief market strategist at TD Ameritrade. "Even the most active traders have a long-term investment portfolio," he notes. 

There are many ways to structure an investment portfolio. Some active traders choose to lump 80% of a portfolio into long-term investments and 20% into a short-term trading account. "It’s up to the individual on how they want to allocate. But, it always comes back to the question of risk," Kinahan says. 

Short-term Portfolio Considerations

Kinahan highlights two questions you can ask yourself as you consider what ratio is appropriate: 

  1. What percentage of a portfolio do you want to hold with fewer adjustments that you check maybe once a quarter?
  2. For your trading portfolio, how much time do you have to commit? Can you check a few times a day or a few times a week? 

The key factor, Kinahan reiterates is to understand your risk. "Have a plan before you go into a trade and know where you’ll get out," he says. Also, remember that some investors look at market movements as a friend. "Market movements could offer an opportunity to buy more of a good company that you like and have done your research on," Kinahan says. 

Long-term Portfolio Considerations:

Sam Stovall, managing director, S&P Global Market Intelligence, outlines the three cardinal rules of long-term investing: 

  1. Don't skimp on stocks since your goal is to outpace inflation and taxes.
  2. Build a diversified portfolio.
  3. Ignore fluctuations and pundits. Typically it's better to buy than bail. 

Rule Number 1: Don't skimp on stocks, since your goal is to outpace inflation and taxes. 

What is the basic reason you invest to begin with? "To accumulate a nest egg to make sure you that you have enough money 20, 30, 40 years down the road to live comfortably," Stovall says. 

This in essence involves deferred consumption. "You want to make sure that you can afford the can of Coke that costs $1.50 today, but cost 15 cents 30 years ago. Don't skimp on stocks because they are the only asset class that has consistently outpaced inflation and taxes," Stovall says. 

Rule Number 2: Build a diversified portfolio. 

Stocks should not be the only things you own. Make sure you own a diversified basket of investments, Stovall says. The goal is to "invest in some asset classes that zig while others zag," he says. Diversify among low correlated assets. 

Example: "While bonds don't offer the growth potential that stocks do, they are the only asset class that has shown a negative correction to stocks. Traditionally, bonds have risen, when stock prices fall," Stovall says. 

Chew on this historical statistic: "In 2008, when the S&P 500 fell 37%, Treasury bonds with maturities of 20-years gained 24%," Stovall says. 

How much is enough? A classic rule of thumb for stock/bond diversification used to be: bonds allocation percentage = your age. 

Today, since people are living longer, Stovall says that rule has been tweaked to: stocks allocation percentage = 110 minus your age, and remainder allocated to bonds. 

Rule Number 3: Ignore fluctuations and pundits. Typically it's better to buy than bail. 

"Ignore fluctuations in the market and your portfolio and ignore pundits who tell you to buy or sell in the same day," Stovall says. When it comes to downturns and corrections, "the markets often surprise investors with the speed of their recovery. Typically, it's better to buy then bail on market declines," Stovall says. 

Keep in mind that while some rules always sound great on paper, like making room for stocks, for some investors, like those in the "wealth preservation" phase and past the "accumulation" phase, may not be right for everyone.  Also, while simple stock / bond ratios in a portfolio can be a great starting point for many investors they are just that -- a start -- and many investors will look at their time frames, risk tolerance, and goals to work up a custom stock / bond split. One investor's 60/40 may be another's 30/70.

Class dismissed. 

Let’s Figure Out Retirement Planning

Whether you need a little guidance or a lot, we can help. Speak with a TD Ameritrade retirement consultant at 800-213-4583.