When the people of Britain voted to leave the European Union, it was the US stock market that, initially at least, went into a tailspin. Interestingly, financial experts say the terrified response of investors was unnecessary. It is indeed possible to create a safe, solid portfolio that will protect you from world events beyond your control.
An overreaction to the surprise vote
In the week leading up to the Brexit decision, investors seemed optimistic about Britain remaining in the European Union. The surprise result of the vote caused a massive selloff, and the Dow Jones Industrial Average was down 610 points at close—it’s eighth-largest point loss ever.
“I would argue the Brexit simply is not a game changer for US investors,” says Robert R. Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pennsylvania. “It is merely the crisis de jour in the financial markets and is overhyped. The 24/7 financial media deems everything a crisis.” That view is supported by the performance of the market since then, as the average bounced back within a few days, and has spent much of the summer at record-high levels.
Johnson’s best advice for investors, in response to Brexit and other unprecedented events, is to do absolutely nothing. “Investment success is achieved by having an appropriate long-term strategy and avoiding short-term noise.”
Michael Fleischer, senior vice president of Morgan Stanley in Troy, Michigan, explains that financial planners don’t run from events like Brexit. “We remind our clients that corrections in the markets are something they should be prepared for and expect,” he reports. “The key is to have in place an investment plan based on your short- and long-term goals and make decisions based on that, not on current events or the news.”
Fleischer’s emphasis on having a plan and sticking to it is essential– especially when considering long-term goals, like funding your children’s college education and planning for your retirement. In addition to consulting with a financial planner, you should consider conferring with an estate planning attorney.
Creating a smarter portfolio
Britain’s vote is just the beginning of great uncertainty in Europe, which will be echoed around the world. Luke Glofcheskie, investment advisor at EchelonPartners.com, says investors can avoid losing their financial footing by sticking with solid investing principles:
Planning is critical. Every investor should have clearly defined investment goals and a plan for how to achieve them. “No matter what your goals, a plan will help you remain calm in a market slump and prevent you from panicking,” advises Glofcheskie.
Diversifying across asset classes & sectors can reduce portfolio risk. The asset classes are essentially categorized as: stocks, bonds or fixed income, and money markets. Diversifying within one of these asset class minimizes risks surrounding a company, sector, or market, explains Glofcheskie. Diversifying across asset classes minimizes common risks associated to each asset class. For example, buying stocks in a company is often considered high risk, high reward. Conversely, buying government bonds is relatively low risk and low reward.
Risk and reward go hand in hand. Investments have different types of risks. Glofcheskie says it’s crucial for you to know your appetite for risk and what you are comfortable taking on with your investments. So, if you are comfortable with the possibility of losing your investment, then it may be worth going after exiting yet uncertain stock options. Don’t spend the milk money on risky investments.
Earn interest on interest. The compounding effect of returns can build real wealth in the long term. “Your time in the market matters more than the timing of the market,” says Glofcheskie. The earlier you begin, the better.
Asset allocation is more importnat than individual investments. Asset allocations are strongly correlated to a portfolio’s long-term returns. The asset allocation should first and foremost analyze the trade-off between risk and return. In simple terms, a “high risk” portfolio may be comprised of 90% stocks and 10% bonds, whereas a “low risk” portfolio might be 30% stocks and 70% bonds. Furthermore, the financial needs (what do you want to do with this money?), risk tolerance (how willing are you to lose it?), and time horizon (when do you want to cash out?) should be accounted for.
Hold on to your winners and sell your losers. Don’t allow personal attachments to affect how you manage your portfolio. Sometimes, an investment you’re rooting for will do badly. “Don’t get attached to an investment, hoping that it will bounce back before you finally dump it,” adds Glofcheskie. “Take your losses quickly and your profits slowly.”
Investors should not be strangers to their investments. Knowledge is power. Understanding the characteristics of each investment may be time-consuming, but the rewards and sense of security are well worth it. “It is much simpler to create a portfolio if you know the role of each investment,” remarks Glofcheskie.
Get the best advice you can and think for yourself. Professional help costs money, yet it can pay off in the long run. “An advisor helps to clarify goals and simplify a complex plan; however, you will still be heavily involved in the entire process,” Glofcheskie explains. “Two head—yours and your advisor’s—are better than one.
Drown out media noise. “The media are in the business of selling stories,” Glofcheskie offers. “When a market falls a few points, the media tells us the world is going to end. But the next day, the market is back up and everything is rosy. Don’t confuse entertainment with advice.”
Don’t panic. A solid, long-term investment plan with an asset allocation that makes sense for your long-term goals will carry you through most any short-term world event. Remember, you’re in this for the long haul.