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Importance of Asset Allocation
Performance Over Time
This chart shows the performance of asset classes over two decades. As you can see, not a single fund performs at the highest rate over the entire time period. Investors have a tendency to chase returns and invest in what is hot at that time. That Strategy has a tendency to fail.
Following a set asset allocation Strategy and not falling prey to emotional investing is the best way to see consistent returns.
Importance of Diversification
It is commonplace for new investors to choose either stocks or bonds when creating their initial investment lineup. As you can see above, both stocks and bonds have wide variances in their performance. This can wreak havoc on an investment portfolio.
You've heard the old saying: Don't hold all of your eggs in one basket. The same is true when investing. When choosing your investments it is important to diversify your lineup by choosing a mix of stocks, bonds and their underlying asset classes. This Strategy lends to a more even rate of return.
Understanding Market Timing
You've set an asset allocation Strategy, you've diversified your fund lineup, you should be set! But - there is a hot item on the market that promises wild returns. It is easy to get caught up in emotional investing.
The chart above shows how an investor that stays with their original Strategy has a tendency to see higher returns than those that chase returns and modify their Strategy based on market fluctuations.
Investment Behavior Gap
Carl Richards, an author, artist and financial advisor, coined the term “behavior gap” to describe this gap between the higher returns investors could earn and the lower returns they actually earned.
Even in a spectacular year like 2013, investors badly trailed the market because they often piled into funds after big gains and sold after big losses. Buy high, sell low. This further enhances the need for a fiduciary advisor to lend individual investors guidance in times of difficulty as well as those that seem more lucrative.
DALBAR’s data actually goes back to January 1984. They cover several bull and bear markets, the 1987 crash, the Internet boom and bust, and the financial crisis. It’s a great laboratory for studying investor behavior under wildly different circumstances.The table at the top of this story shows the spread between returns investors could have gotten by staying invested and what they actually made. Even in a spectacular year like 2013, investors badly trailed the market because they often piled into funds after big gains and sold after big losses. Buy high, sell low.
They earned 25.5% from their stock investments last year, while the market itself soared 32.4%. In fact, the gap actually widened in 2013 when all people had to do was sit back and count their profits.