We have long counseled that investors will do quite well over time when they adhere to a well-devised long term investment plan. Long term data demonstrates that the most significant driver of a portfolio’s ultimate returns and volatility is the broad investment allocation to stocks and bonds. A good long term plan begins with this allocation and depends on the discipline to adhere to the plan no matter how the financial markets behave. Such a plan should be revised infrequently, usually only upon a significant change in an investor’s circumstances, and never simply as a reaction to the financial markets.
The second most important driver of a portfolio’s ultimate returns and volatility is tactical asset allocations (allocations to sub-asset classes within the broad asset classes). While noticeable, the effect is actually relatively minor.
For the vast majority of investors, everything else, including security selection, short-term trading, and market timing, is almost irrelevant and in many cases subtracts from portfolio performance. Most amateur investors and far too many so-called professional investors over-emphasize selecting securities by trying to pick the “right” stocks or bonds, or engaging in continuous short-term trading, or attempting major market timing by going all in or all out from one asset class or another. This happens in large part because it feels sexy to have activity, no doubt aided by bombardments of stories or advertisements or Wall Street institutions seducing them with promises of wealth through either a get-rich-quick mentality or a way to avoid market declines.
Of course, simple statistics dictate that there will be some investors who are successful by using approaches that are detrimental to the vast majority. If a million people flip a coin twenty times about ten of them will get all heads or tails, but that does not automatically make them experts worthy of following or seeking advice. The failure to understand the statistics behind certain activities, the significance of luck, and the role of emotion entices many to pursue certain activities they otherwise would not.