The financial markets will always be somewhat unpredictable. Some investors can cope with this fact, but others find it almost intolerable – and so they look for rules of thumb, or “anchors,” to keep their portfolios stable during all economic environments. Some of these anchors may have some value, but, before you employ them, ask yourself, ‘Are they right for me?’
Let’s take a look at some common rules of thumb:
Buy low, sell high – This would be a great piece of investment advice – except that it’s virtually impossible to follow. Nobody can accurately predict when the market has reached a “high” or a “low.” Consequently, you can’t really use “market timing” as a sound investment strategy. Instead, buy quality stocks and hold them for the long term – at least until your needs change or the companies themselves have moved in a different direction.
Own a percentage of stocks equal to 100 minus your age – The rule behind this guideline is fairly straightforward: The younger you are, the higher the percentage of stocks you should own. So, for example, if you are 30, the “rule of 100” suggests that your portfolio should consist of 70 percent stocks, with the remaining portion being made up of fixed-income vehicles and cash equivalents. But if you’re 50, your holdings should consist of 50 percent stocks, according to this rule, and once you’re 70, stocks should only make up 30 percent of your portfolio. While the basic idea behind this rule may make some sense, the “100 minus age” formula could result in a portfolio that is much too conservative for you. Instead of allocating your investments according to a rigid numerical equation, try to build and adjust a diversified portfolio based on your goals, risk tolerance and time horizon.
Save and invest 10 percent of your gross income – If you follow this rule of thumb consistently throughout your working life, you probably would be doing a lot better than most people – because Americans’ savings rate is abysmal. And yet, the 10 percent figure, in isolation, may not be all that meaningful. The amount you need to put away each year depends on a variety of factors: your age, the amount you’ve already saved, the type of lifestyle you’ve envisioned for your retirement, how much your spouse is saving, etc.
Count on all stocks to bounce back – Although past performance does not guarantee a future result, the stock market, as a whole, has always rebounded from down periods – but the same is not necessarily true for individual stocks. In fact, some of them never recover from major losses, or, if they do, it takes many years – and during that time, you could have found better opportunities for those investment dollars. Many investors hold on to losers far too long because they dislike admitting they may have made a mistake. Don’t let this false pride get in your way; if a stock or other investment just isn’t panning out, get rid of it and move on.
Chart your own course
As we’ve seen, some of these rules of thumb contain elements of truth – but they simply may not be right for your individual situation. In the long run, you’ll increase your chances of success by making decisions based on your individual goals and needs, and on the qualities of specific investments.
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