The Most Important Investment Decision
You might think the most important decision an investor can make is which stocks to buy and sell. However, research shows that over a long term, the good choices are generally offset by the bad ones. And it doesn’t matter whether it is an individual investor with no experience whatsoever, or the highest-paid money manager in the country. Stock-picking is such a hard business that virtually no one can do it well.
Then what makes some investment portfolios perform a lot better than others? It turns out that the one decision that outweighs any other in its importance is when to invest in stocks, when in bonds, and in what ratio. An investor who put everything in stocks a year ago would have lost half of their capital. An investor who put everything in bonds a year ago would be looking at huge gains. Of course, going back a few years, the picture can be completely the opposite.
The best investors are those who can time the market a little. In other words, they would guess whether the next year would be the year of stocks or the year of bonds. And then put more money into that asset. Of course, they won’t always get it right, but that’s ok. As long as they are right more often than not, they will do very well over the span of a decade or two.
In economic boom, stocks usually do better than bonds. In recession, it is the other way around. The trick is to predict whether the economy is going to do well before others figure it out. By the time the whole country knows we are in recession, it is too late to switch from stocks to bonds because the prices will have already adjusted to the new reality.
Most investors do not feel confident enough to predict the future of the economy. Such investors should not try to time the market. The trouble and cost of trading is not worth it if all one has to go on are random guesses or advice from a newspaper. By the time the newspapers know what’s going on, the markets have already moved. The best approach is to decide on a constant allocation between stocks and bonds, and never change it (except for tax reasons).
Experts generally recommend 60% investment in stocks and 40% in bonds as something that works best over the long run. However, recently, some researchers have argued that the US equity markets do not have as bright a future as most people think. They advocate moving most of the money into bonds, e.g., 70% bonds and 30% stocks. Perhaps those who are willing to live with more risk should use the old approach of 60% / 40%. Those who are not as interested in making risky bets, should stay with 60%-70% in bonds. And don’t forget that the best performing bonds are the long-term ones (10 years or longer).
With investments you have to bet with your instincts on what you believe is going to get you a big return on investment and this takes a great amount of risk taking. However, if you’ve been hesitant about investing because you’re concerned about risking all your saved money – especially in these times – there are other investment products that have very low to no risk you can look into, such as Certificates of Deposits (CDs), Money Market Accounts, Mutual Funds, etc.
