By Dan Hunt, Senior Investment Strategist
One of the biggest mistakes I see investors make is confusing investing with stock picking. Ask many people how their money is invested and they might quickly jump to tell you the latest hot stock they’ve purchased and the investment thesis that explains why they think it’s going to take off.
What is their goal? Probably just to make some quick, easy money, which neuroscience has shown makes us feel good.
Unfortunately, behavioral economics tells us that acting on such impulses tends not to end well. To be true to the term, investing must start with a specific goal corresponding to a specific time horizon. The goal itself could be anything: buying a new car in two years; purchasing your first home in five years; or retiring in 40 years. What’s most important is to have the goal be the focus of your approach.
Once you’ve identified a goal, an investment plan can take shape. How much savings can you devote to it? How much time do you have? How realistic is the goal given the first two questions and the amount of risk you feel comfortable taking? By answering these questions, you will have gone a long way to devising an investment strategy that can help you achieve that goal.
Saving for Retirement
Let’s consider someone saving for retirement. After all, that is typically the focal point around which other financial goals orbit. A plan for that goal could include a desired amount of spending needed to fund your lifestyle in retirement, an intended amount of savings each year that would be needed to achieve that goal, and a suggested asset allocation. There are a lot of moving parts, with adjustments that need to be made along the way. However, many tools now exist, including the kind of digital software that Morgan Stanley has developed, that can help you connect the dots and track moving targets in changing markets.
Since equities are more volatile, but usually return more than bonds over a market cycle (around seven years, on average), investors may need a higher percentage of their portfolio in stocks to reach their long-term goal. For example, 35-year-olds could have 80% of their portfolio in stocks, and possibly more depending on their circumstances and the market environment. That age group could likely withstand the higher volatility in stocks.
If the goal is less than a full market cycle away, the investor should probably take less market risk to avoid the possibility that the stocks could suffer a substantial decline close to when he or she would need to convert that equity into cash. An equity allocation of 30%, for example, may be appropriate for someone later in retirement who relies on her portfolio for a substantial portion of living expenses.
Once the asset allocation is set, careful security or fund selection techniques can improve performance, reduce risk and lower costs.
What if a retirement plan is off track? At that point, investors can use other levers to help fulfill their goals–things like increasing savings, pushing back retirement a year or two or coming up with a plan to work part-time in retirement (for more ideas, see “What to do if You’re Off Track on Your Goals”). While these kinds of trade-offs may not be desirable, they may be the best way to manage the risk of more serious shortfalls in your finances.
Goal-Setting and Tracking Matters
What I hope you’ll see in these examples is the importance of setting a goal and tracking your progress against it when investing. If you don’t have a plan, you may lack perspective on how chasing a hot stock in the short-term can damage your long-term finances. More to the point, you may not realize how positive the impact of compounded returns from sound strategies can be over time. You also may not realize that you need to make adjustments along the way to stay on track.
There is no magic stock-picking formula that will make your most ambitious desires a cake walk. In fact, while security selection is important, research shows that what matters most in investing success is asset allocation–the decisions you make to invest your money across different sectors of the stock market and different types of securities, including bonds and cash.
When you have a goal in mind, your time horizon and risk tolerance will inform your decisions. Setting up your asset allocation in the context of a realistic plan that can be adjusted for life and market uncertainties should put you well on your way to achieving your financial objectives.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.
Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors. Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this material.
This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or warranty with respect to the accuracy or completeness of this material. Morgan Stanley Wealth Management has no obligation to provide updated information on the securities/instruments mentioned herein.
The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors. Estimates of future performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein.
This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol.
Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.
Morgan Stanley Wealth Management is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section 15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.
This material is disseminated in the United States of America by Morgan Stanley Wealth Management.
This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.
© 2018 Morgan Stanley Smith Barney LLC. Member SIPC.