By Michael McKeown, CFA, CPA – Chief Investment Officer
For hundreds of years, sailors used the North Star as a guide when land was no longer in sight. The North Star, also known as Polaris, is located at the north celestial pole, the point around which the entire northern sky turns. While most think it is the brightest star in the sky, it is actually the 50th brightest. But its location is easy to spot, which helped sailors navigate even during the roughest of seas.
While most look back at the period from 2010 to 2019 as a straight-up bull market in stocks, there was plenty of risk along the way. U.S. stocks fell 7% to 20% during the following events each year in the last decade.
This year stocks fell 35% in a month due to the global pandemic. There is always a reason to sell if you pay attention to the news. Investors need something more as a guide.
A financial plan is the process by which investors find their own North Star. Studying how spending, taxes, and various allocations work to achieve those goals is a necessary step.
This process brings the proper mix between stocks and bonds. It may be that an allocation to stocks of 35%, 50%, or 65% is necessary to achieve the long-term planning goals. This weighting is the Investor’s North Star.
Studies show that asset allocation, or the mix between stocks, bonds, and real estate, drives over 90% of the returns for investors. The other factors like timing and security selection are less impactful. This is why the Investor’s North Star is such a powerful guide.
If an investor has a 50% target to stocks and markets fall, the weighting to stocks will be below target. Buying stocks while they are down and rebalancing back to the target will get them in line with their own North Star. However, implementing this in times of duress can be a challenge.
If stocks rise above the 50% target, selling to regain the target weight is necessary. Still, the greed factor and the desire to hold on to winners can creep in as a reason to avoid staying in line with their North Star.
Today investors face plenty of reasons to worry. The coronavirus is still a major health risk and in turn one for the economy. Uncertainty around the U.S. presidential election and potential policy changes is another risk.
Still, investors can look to their financial plan and the North Star it produces. This will allow a response to both the rough seas or calm waters the market brings.
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