Sticking with Your Investment Plan

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Question: When I started my investment portfolio a couple of years ago, I decided to go with a very aggressive mix.  Even though I intend to use this money for my son’s college education, which is ten years away, I have found that I am not comfortable with this stance.  I would rather take a more conservative approach and hopefully see slow but steady growth.  Please let me know if my thinking is correct.

Answer: Let's say your account is worth approximately $100,000.  If you put the $100,000 into a “sure bet” (the 3% fixed-income investment you mentioned) it will be worth $134,392 in 10 years.  If you keep it allocated as it is now, in a diversified portfolio of various asset classes, and it earns an average annual rate of return of 6% per year, it will be worth $179,085 in 10 years.  If it earns 8% per year, it will be worth $215,892. That’s the power of compound interest. You would be paying a big “penalty” for being too conservative. 

It is reasonable to expect 6-8% as an average annual rate of return over 10 years on a diversified portfolio of equity and fixed income mutual funds.  However, there is no guarantee. And every diversified portfolio has some volatility.  The volatility is amplified if you watch it closely on a day to day basis.  The volatility diminishes over longer periods of time.  For example, the volatility for a five-year period is less than for a one-year period, and the volatility for a ten-year period is less than for a five-year period. 

As hard as it may be, I encourage you to stick with your program.  Here is a way that might help.  Take a look at the performance of the very same portfolio you have now over the past ten years.  You can get the past performance of each mutual fund from various sources on the internet (such as Morningstar.com) or directly from the fund companies.  If the fund has not been around for 10 years, then use the performance of the asset class benchmark or index fund.  Now, take a look at the performance of your portfolio on a month by month basis.  Notice how volatile it seems.  Up and down, up and down, etc.  One month it’s up, another month it’s down – almost like riding a roller coaster.  Follow it again, but only look at it on an annual basis.  Notice the difference?  Now look at each of the six five-year periods over the last ten years.  See how the volatility has diminished? 

Your problem is that you are watching your portfolio performance too closely.  What you should be watching is the portfolio allocation and balance between the asset classes to keep them in line with your investment policy.  The rest will take care of itself. 

One of my toughest jobs as an investment advisor is helping my clients realize what their expectations should be and then helping them stick to their plan during market swings.  Their goals are clear – and on paper, the plan to achieve those goals is clear.  But when the waters get rough and the boat starts to rock, that’s when we have to hold tight and stick to our course.

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to ken@montereypw.com.