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The Proven Path to Smooth Returns

Selling out and sitting on the sidelines is essentially a form of speculation, rather than investing.

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INVESTORS WANT TO MAKE the most of market opportunities. Most of the time, that wish comes in the form of trying to identify a stock poised for big price appreciation.

However, the desire to avoid all losses by bailing out and sitting in cash may preclude gains that could be readily available.

Here’s why: Many stock-trading methodologies, newsletters and media figures recommend a quick exit to cash when markets flash any sign of trouble.

Avoiding Losses Can Lead to Missed Opportunities

No one wants to see portfolio losses. It can be problematic when investors act on their feelings of loss aversion. Investors often sell out when they have a hunch or a fear that a downturn is on the horizon. Sometimes these fears are driven by news reports about chaos in Washington or the world. There is no shortage of such reports, thus giving investors a more or less permanent sense that doom is around the corner.

Although it may seem like a good idea to remain in cash and wait out a downturn, investors may actually be missing opportunities that way, rather than protecting themselves.

Selling out and sitting on the sidelines is essentially a form of speculation, rather than investing. People who do this are making a bet on a change in market direction, as well as the timing of that change. It’s very possible to cash out at the wrong time; instead of the market declining, as you believed it would, it rallies. Then you are faced with a second choice about getting back in. There’s plenty of room to time that trade wrong, as well.

A Well-Rounded Portfolio Can Help Protect You

A more prudent approach is to develop a portfolio that captures better-performing asset classes at any phase of a market cycle.

Recent asset-class performance supports that approach: In the first quarter of 2019, domestic and international stock and bond asset classes rose. In the previous rolling one-year time frame, broad asset-class performance diverged:

  • The U.S. stock market gained 8.77%.
  • International developed markets lost 3.14%.
  • Emerging markets lost 7.41%.
  • The U.S. bond market gained 4.48%.
  • The international bond market gained 5.23%.
  • Global real estate investment trusts gained 13.93%.

Investors who bailed out likely would have missed the subsequent rallies. It sounds easy, in theory, to wait out a downturn and re-invest when the coast is clear. But there is no way of discerning an “all clear” signal. Markets move up and down all the time, with regularity. Meanwhile, bad news continues to pour in from around the globe, complicating the difficult decision about when to re-invest.

It’s difficult to hold onto an investment that’s declining, but remaining broadly diversified is a proven way to smooth returns through various market conditions.

Your allocation should be tailored to reflect the risk-and-return profile necessary to meet your financial goals.

Stocks or Bonds? Balance Both

It’s pretty well known that investors need the right proportion of stocks to bonds, but those broad asset classes must be allocated properly. Investors must be certain they own both large- and small-company shares, value and growth, as well as all industries and stocks representing global regions. As we saw, different geographical markets don’t yield the same returns at the same time.

On the bond side, it’s important to hold instruments with a short duration, as well as high credit quality. These bonds should represent debt of governments and corporations, again, reflecting a global allocation.

Those strategies will assure that you are invested in the top-performing asset classes. Investors worry about missing opportunities, which is understandable. However, attempts to pick winners are almost certain to miss key opportunities. For example, not many investors would have been lucky enough to pick three of this year’s top-performing large-cap stocks: Xerox Corp. (ticker: XRX) is up 65.18%, Anadarko Petroleum Corp. (APC) is up 72.45% and Coty (COTY) is up 84.65%.

Investors who owned a fund tracking the S&P 500 index or the Russell 3000 would have captured those performances.

Picking individual stocks and bonds won’t come close to achieving a broad global allocation. Passive or index funds that track broad areas of the market are a much more efficient way to take advantage of opportunities the market serves up.

Once you have a portfolio allocation that takes into account your time horizon, risk tolerance and spending needs and wants, resist the temptation to tinker. While broad diversification won’t completely protect you from losses when any segment of the global market declines, it will assure that you own the best performers alongside the worst.

Balancing your returns that way is not as exciting as picking a big winner, but it’s definitely a more reliable approach to owning top performers, while also mitigating downside risk.

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About the Author

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Kate Stalter

CMO and Senior Financial Advisor

Kate is a Series 65-licensed advisor, has hosted the Daily Stock Analysis and Market Wrap videos on Investors.com, and taught Investor’s Business Daily live seminars. She contributes to Forbes, US News & World Report and TheStreet. Kate’s primary focus is helping clients who face decisions about portfolio allocation, Social Security strategies, insurance needs, estate planning, college funding and all manner of financial questions.