Lessons Learned From the Current Financial Crisis
Financial markets have been taking investors on quite a roller-coaster ride lately. At Grand Wealth Management, we recommend that you consider the recent turmoil an opportunity to learn, or be reminded of, some important truths about financial markets and investing. Knowing these truths, which we’ll talk about below, can help you make wise decisions and avoid mistakes in your portfolio.
Where There’s Return, There’s Risk
The financial crisis serves as a good reminder of the eternal correlation between market risk and return. Typically, to have any chance of achieving high returns over a long term of seven years or more, you need to accept a relatively high degree of market risk. But remember that all investments pose risk in some form and to some degree. If, for example, you overzealously avoid investments you perceive as posing too much market risk, you run the risk that your returns will be so low that they can’t keep pace with inflation.
Markets Are Unpredictable
Wall Street firms often tout their ability to navigate clients through the complexities of the financial markets, suggesting they possess some special insight that helps them create better results for their clients. Recent events, however, confirm that Wall Street is subject to the same market forces as everyone else. In fact, these firms have made some of the biggest investment blunders on record, concentrating large amounts of their own capital in securities tied to subprime mortgages. History has shown us time and time again that even the most sophisticated investors – including those on Wall Street – cannot predict the future.
Financial Markets Work
While we hesitate to say that markets are “working” at a time when they’re acting so erratically, they are, we believe, doing exactly what they’re supposed to do – moving toward equilibrium. Along the way, prices have to be set, securities must be bought and sold and trades need to clear – with all this commotion sometimes making for a bumpy ride. Markets don’t always get pricing right in the short run, but that’s the nature of risk. And, over longer periods of time, markets have proven to be extremely efficient at pricing securities.
Having a Plan Helps
In a recent survey, 88% of individuals working with a financial advisor to develop a comprehensive plan felt they had a clear direction. Clients with such a plan had a 50% higher comfort level than respondents without a plan. The survey was conducted by the Financial Planning Association and Ameriprise Financial Services.
Here’s the bottom line on surviving market turmoil. Instead of reacting reflexively to short-term highs and lows in financial markets, focus on keeping your long-term asset allocation in line with your goals, time horizon, return objectives and risk tolerance. To manage risk, make sure your portfolio is well-diversified, with both domestic and global investments contributing to your diversification. And avoid market-timing, because even investment pros have a tough time winning at it.