If you've ever traveled to an unfamiliar location, you no doubt appreciate the value signs provide. Mile markers, highway locators and distance signs, speed limits – these and many others are designed to help you arrive safely.
But what signs can help point you in the right direction on your investing journey? Here are four to follow:
Most investments can be grouped by how their prices change over time: Your stock investments move up and down with the overall stock market, frequently experiencing sudden price declines and rebounds. In contrast, prices of fixed-income investments (such as bonds or cash) generally fluctuate less but frequently move in the opposite direction from stock prices. That’s why owning the appropriate combination of both is the starting point for creating a well-diversified portfolio that fluctuates less over time.
If you’ve worked with your financial advisor to personalize your portfolio’s mix of stocks and bonds for your current situation and comfort with risk, you’re on your way toward your financial goals.
Although stocks tend to fluctuate more than bonds, they have performed better, too, which is one of the reasons to make sure you have enough invested in stocks. As the chart shows, U.S. small companies (small- and mid-cap stocks) outperformed U.S. large-cap stocks and international developed-market stocks. And those equity investments together outperformed bonds and T-bills, as well as inflation. Historically, inflation averaged 3.6%, but we expect it to remain at 3% or lower in the future.
After several years of lagging, international stocks have outperformed U.S. stocks in 2017. We think they’ll continue to perform well due to the synchronized global economic rebound and more attractive valuations. International stocks are just one of several asset classes that can potentially improve the performance of a diversified portfolio over time and help reduce its volatility, helping keep you on the road when other investors exit.
Stock markets are near all-time highs, volatility has been low, and stock valuations are above-average when comparing prices to earnings or other fundamentals. Over the past five years, U.S. large-cap stocks returned 13.8% per year, about twice as much as we think their long-term returns will be. You can help avoid disappointment by making sure you’re not expecting double-digit stock returns to continue.
It’s tempting to think you’ll keep zooming along the road, but conditions may be changing, as the Federal Reserve slowly raises interest rates. We think it’s realistic to prepare for slower speeds and a rougher ride ahead, even while you’re moving in the right direction. Realize that when returns are lower and volatility is higher, it may take longer or require some adjustments to reach your goals. That perspective can help you decide when to retire or how much to put aside to pay for education.
Instead of embracing realistic expectations and a time-tested approach, you may be tempted to react to predictions about bubbles ahead or another financial crisis on the horizon. If you’re considering the exit ramp in response to such predictions about market downturns or unexpected shocks, how will you respond when an inevitable pullback occurs? Will you stick to your principles or possibly detour and slow your progress? We don’t think another financial crisis is likely. But we expect a 10% stock market pullback as part of a return to normal market volatility – and also see it as an opportunity to add stocks at lower prices.
During good times, it’s easy to feel in control and confident about the road ahead. But when the investing weather turns dark and rainy, it’s more difficult to be sure you’re still headed toward your destination. That’s when meaningful guidance, including signs you’re still on the right road, can help you stick to your investment principles, take advantage of opportunities and stay on track.
Past performance is not a guarantee of future results. Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Small- and mid-cap stocks tend to be more volatile than large company stocks. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events. Diversification does not guarantee a profit or protect against loss in declining markets.
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