A smart approach for long-term investors is to lean on the time-tested basics, including personalized financial advice. Here are six principles that can help inform discussions and decisions with your advisor.
1. Invest early to take advantage of compounding interest
Time is your greatest ally as an investor. The earlier you start investing, the longer the runway for your portfolio to grow. Compounding growth occurs when an asset's earnings — from capital gains, dividends or interest — generate additional earnings over time. In sum, it’s the process of earnings on earnings.
Here’s an example of tax-deferred compounding growth in a 401(k) account.
2. Invest for the long term
As stock prices throughout 2021 have risen to record levels, some investors might be waiting for a downturn to invest. While the desire to maximize purchasing power is understandable, trying to time the market may result in missing bigger returns.
For example, if you wait to buy when the market drops, you could potentially miss the gains that often occur before a correction. And so far in 2021, investors waiting on the sidelines have missed a 17.2% return from the S&P 500® Index.1
History shows that, over long periods, asset prices have moved in an upward direction. That’s why staying invested throughout market and economic cycles can be a smart decision for most investors.
1 As of Sept. 14, 2021.
It is not possible to invest directly in an index.
3. Invest consistently with dollar-cost averaging
If you’ve contributed to a 401(k), you’re already familiar with dollar-cost averaging. You invest a fixed amount of money into the same investment vehicle(s) on a regular basis — such as monthly or quarterly, for example — regardless of how the market is performing.
With dollar-cost averaging, you naturally buy fewer shares when the market is high and more shares when the market is low. This systematic approach can help you gradually build wealth by diversifying the prices at which you buy more shares of a stock, for example. (Neither price appreciation nor profit is guaranteed, however.) It’s a way to hedge the risk of buying too much at high prices and too little at low prices.
4. Invest according to your risk tolerance
The amount of risk you’re willing to accept in return for potential rewards is a key factor that influences your portfolio’s investment mix. By keeping your investment choices aligned with your risk tolerance levels, you may have more confidence and could avoid the following scenarios:
- Investing below your risk tolerance: You could be forgoing better returns over time.
- Investing above your risk tolerance: A decline in stock prices might prompt you to sell at a lower price or miss a market recovery.
If your risk tolerance changes (as it might at different life stages), it’s important to talk with your advisor so they can recommend changes to your portfolio.
5. Prepare for the unexpected with asset allocation and diversification
When providing investment recommendations, your financial advisor will likely use an asset allocation strategy. Time-tested and tailored to you, asset allocation is the act of investing in different asset categories: stocks, bonds, alternative investments and cash. Your advisor will factor in your goals, risk tolerance and time horizon.
Diversification goes one step further to invest in multiple stocks and bonds, for example, across a range of regions, sectors or industries. Together, the two disciplines can help reduce volatility in portfolio value and enhance growth potential over time.
6. Regularly review your portfolio with your financial advisor
When the stock market climbs higher, as it has in 2021, your portfolio can drift away from your original asset allocation targets and the risk profile that support your financial goals. Your advisor may recommend a rebalance, which is the strategic movement of assets back to your original allocation amounts.
Here’s a hypothetical example:
- It’s early 2020, and your portfolio was split 50-50 between U.S. stocks and bonds.
- Then, the pandemic caused a brief bear market (i.e., stocks fell more than 20%) in the first quarter, but you stayed invested.
- In May 2021, you met with your advisor for your annual review. The stock index was 30% higher and the bond index was 5% higher, pushing your portfolio’s makeup to 55% stocks and 45% bonds.
- Since stocks are riskier than bonds, your portfolio has a higher volatility profile than what you’re comfortable with. The problem could intensify over time given stock returns have historically exceeded bond returns.
- In this situation, your advisor may recommend a rebalance of your portfolio to your original 50-50 starting point.
Have more questions? Seek out personalized advice from your advisor
Cultivating a long-term investment mindset and regularly connecting with your advisor for personalized advice can help give you the peace of mind to stay the course to your financial goals. If any market developments are giving you pause, it’s time to connect with your Ameriprise financial advisor. They can provide perspective unique to your financial goals and portfolio.