A sound investment strategy may not mean what you think it means. Forget about all the hype you hear from day traders, Forex traders, and all the other noise out there. In fact a sound strategy is actually quite boring. Let me explain.
In order to have a sound strategy you MUST know what you want to accomplish, and what your time frame is. Think if it as a road map. You must know where you are going and when you have arrived. The best strategy is the one that will get you there with the least risks. We manage these risks with a proper asset mix.
By asset mix we mean stocks, large cap, mid cap, small cap, value, growth, domestic, international, global. This can be quite confusing for the novice, but I will explain all this in future writing. We also mean bonds, bonds range in rating from triple A, the safest to Junk, the riskiest. A combination of these can have a place in most any portfolio. Cash is another part of the asset mix. Cash ranges from savings accounts, to CDs, to money markets. Real estate is also an asset that can be combined into the asset mix. My sixteen years of experience in the investment industry shows no advantage in risk reduction or performance increases, so I neither advocate, no include real estate in any of my portfolios.
Time horizons are generally divided into three segments: long, medium, & short. Long horizons are generally 20-25 years or longer. Medium time frames generally range from 5-20 years. Short time frames are usually shorter than five years. Notice I use the term generally to define time frames. This is because based on where you are in life, your goals, and a term I am about to introduce risk tolerance, can have a little bit of effect on how your time frame is measures. Also a good investment strategy is part art, part science.
Risk tolerance is just what it says. What is your tolerance for risk? And another question that doesn’t get asked often enough what is risk? To define risk tolerance we must first define the different types of risks and how they can affect our investment. There are more types of risk than what I am going to cover in this article; it’s more technical than is necessary for our purposes.
The risk that we are all familiar with is loss of principal. In other words, we lose the money we’ve already invested. Most of us are familiar with this after the recent market crash. The second type of risk I want to cover is return risk. Will our strategy offer enough return to meet our goals. The third risk I want to cover is volatility risk. This is the one that gets us in trouble. This is what makes us buy high and sell low. This is where most people make their mistakes.
We use an asset allocation model along with our investment policy to manage our risks and get the greatest return for the least amount of risk. Think of it as a pie chart that tells what types of investments we need and how much of each we need. As long as our goals don’t change, we only need to buy and sell to keep our portfolio balanced.
The investment policy tells us how often we will rebalance the portfolio. It tells us when we will re-evaluate or portfolio to see if our investments still meet our original objectives. It tells us when to buy, sell, and take any cash out of your portfolio.
This article is just an outline, if you will, of a proper investment strategy. As I build this site we will examine the essential elements, time frame, goals, and risk tolerance to learn how you build a successful portfolio that will meet you investment needs. Feel free to read our other article and visit the other pages on this site to learn how to manage your investment strategy.