Investing is a complex endeavor that requires more than just picking stocks or following market trends. Whether you’re a seasoned investor or new to the financial markets, the expertise of a financial advisor can provide valuable insights and strategies tailored to your unique financial needs and goals.
Financial advisors have a laser-like focus on factors within their control. The main ones are:
Asset allocation: “Asset allocation” is the strategic distribution of your investments among various asset classes like stocks, bonds, and cash equivalents. It’s a dynamic process that requires regular reviews to align with your evolving risk tolerance and financial goals.
Asset allocation is important because it helps balance risk and reward. A portfolio with a higher allocation to stocks may have a higher risk but also potential for higher returns. A portfolio with a higher allocation to bonds may have lower risk but also lower potential returns.
To determine your asset allocation, advisors consider your tax situation, risk tolerance, and emotional capacity to handle market volatility.
Global diversification: Global diversification involves spreading your investments across domestic and international markets.
Global diversification reduces risk and increases potential returns by investing in markets that may be affected differently by economic, political, or other factors. By diversifying globally, you can benefit from the growth potential of different markets and reduce the risk of being overly exposed to any single market.
Financial advisors offer valuable insights into how to diversify globally, capitalizing on growth opportunities in foreign markets.
Currency risk: Financial advisors help manage f by considering the impact of foreign currencies when investing internationally. Currency exposure can serve as both a risk and an opportunity.
By diversifying currency exposure, investors can reduce the overall risk of their portfolio and take advantage of potential opportunities in foreign markets.
Low costs: High management fees charged by mutual funds (called “expense ratios”) can eat into returns, reducing the net returns you receive. This is particularly important over the long term, where even slight differences in fees can significantly impact your portfolio's growth.
The SPIVA U.S. Scorecard reports consistently show that most actively managed funds underperform their benchmarks over the long term, especially after fees and taxes. This evidence supports focusing on low-cost, passively managed index funds, ETFs, and passively managed funds.
Factor-Based Investing:
Factor-based investing is a strategy that targets specific return drivers, like company size and value, to potentially enhance long-term returns. It’s supported by extensive academic research, which has shown that tilting a portfolio towards small-cap and value stocks may lead to better performance over the long term.
Financial advisors apply these academic insights to real-world investment strategies to create portfolios optimized for long-term growth.
Alternative investments: Alternative investments are a category of investments that fall outside the traditional asset classes of stocks, bonds, and cash. They include real estate, commodities, hedge funds, private equity, and infrastructure.
Author and financial expert, Larry Swedroe, invests in private debt and drug royalties. His own portfolio is about 40% alternatives. He believes alternatives are appropriate “for anyone.”
Alternative investments often have a lower correlation to the stock and bond markets, which can provide diversification benefits. They can also be more complex and illiquid, requiring more management expertise.
Financial advisors offer insights and guidance on incorporating alternative investments into a portfolio, helping to navigate their unique challenges and opportunities.
Distractions:
Studies have shown that individual investors who try to pick individual stocks or time the market often have lower returns than those who follow a passive investment strategy, like investing in a low-cost index fund.
There’s little evidence that stock pickers can identify mispriced stocks consistently. The odds of picking a stock “winner” are low.
One study examined the period 1983-2006 and looked at 3,000 stocks. It found that 64% of stocks underperformed the Russell 3000 index, and just 25% of stocks were responsible for all the market gains.
Market timing is another failed strategy. All you need to know is summarized in this quote from Fortune Magazine: “Let’s say it clearly: No one knows where the market is going-experts or novices, soothsayers or astrologers. That’s the simple truth.”
Final thoughts
Financial professionals are knowledgeable partners in your investment planning, from foundational principles like asset allocation and low-cost funds to specialized strategies like factor-based investing and alternative assets. Their expertise can help you navigate the complexities of the financial markets with greater confidence.
