As humans, our emotions are powerful drivers behind our decisions. When it comes to finances, the drivers are often greed and fear. Fear is a primary emotion, as it is the basis of the survival instinct.
In bad economic times, our fear and survival instinct lead us to want to protect our assets. Usually this takes the form of pulling them from the stock market and fleeing to the safety of cash or bonds.
A better strategy is to build a portfolio of diversified assets. This allows you manage the ups and downs in your portfolio value without having to “time the markets” with “just in time” management. Timing the markets is a proven strategy for disaster, as no one knows the future. You’ll get in and out of markets as your emotions dictate missing opportune times that no one knows.
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To build a diversified portfolio allocation, you need assets for growth and assets for safety. The younger you are, the less safety you need. The older you are, the more safety you need. While stocks are volatile in the short term, they offer required growth over long periods that will offset the negative impacts of taxes, inflation, and your spending.
Safety can come in many forms. Ideally, you’ll want assets that will rise when stocks are falling — these are also known as uncorrelated assets. These uncorrelated assets are too complex and risky to buy as individual issues. I prefer inexpensive, indexed, mutual funds or exchange-traded funds.
The easiest uncorrelated assets to own are cash and bonds. Other more complex assets that are known as alternatives include real estate investment trusts, treasury inflation protected securities, senior floating rate funds, international assets, commodities, currencies, futures, options, precious metals, and “real return” strategies, which are hedge fund portfolios. Various types of insurance could also work.