Once established with a plan, plan to stay the course
Once an investor develops a reasonable plan for long-term investment, a vital component to its success is for the investor stay the course and stick to the plan. This is perhaps the most challenging part of long-term investing.
Challenges
There are numerous challenges to an investor’s discipline in staying the course. The mutual fund industry, the brokerage industry, and the financial press continually barrage us with suggestions that a mutual fund that has outperformed the market in the past is likely to outperform the market in the future; that you can predict hot stocks or hot funds to improve performance; that professionals can predict market movements. The reality is that little evidence supports the notion that investors can successfully time the markets.
A second challenge to discipline is the volatility of markets and the chance that an investor will bail out of the portfolio in the face of large investment losses.
The table below, offered by author Larry Swedroe, is based on the 1970s bear market, and shows the amount of decline for various stock/bond allocations. As a long-term investor it is inevitable that you will experience market declines of similar, or perhaps even greater magnitude over your investment career.
| Asset Allocation % (Stock/Bond) |
Exposure to Maximum Loss |
| 20/80 | 5% |
| 30/70 | 10% |
| 40/60 | 15% |
| 50/50 | 20% |
| 60/40 | 25% |
| 70/30 | 30% |
| 80/20 | 35% |
| 90/10 | 40% |
| 100/0 | 50% |
Keep in mind that a portfolio must increase in value by a factor of two in order to regain value. For example, a decline of -25% for a 60/40 stock/bond allocation would require the portfolio to appreciate +50% to get even.
The best way to deal with downside risk and stay the course with your investments is to take into account your need, willingness and ability to bear investment risk. For many of us, this means creating a balanced asset allocation that includes bonds to reduce the volatility caused by the stock part of the portfolio, then rebalancing when needed.
Staying the course with a written plan
A good way to maintain investment discipline is to commit your financial plan to writing. This written plan is called an investment policy statement (IPS).
An IPS often includes the following main topics:
- Financial account information
- Investment objectives, time horizon, risk tolerance
- Asset classes to be used and those to be avoided
- Asset allocation targets and rebalancing ranges
- Monitoring and control procedures
While this may sound imposing, a sensible plan need not be complex, as this example statement shows.
Making course adjustments
An IPS should also be a flexible document in that it it accommodates change. Legitimate changes to an IPS include changes in an investor’s life and fundamental changes in the investment landscape.
Life changes include such things as marriage or divorce; birth of children or death of family members; changes in employment status; changes in health status; aging. All of these changes can affect an individual’s risk tolerance, and an IPS should allow for a reset of policy.
Some examples of fundamental market changes include tax-law changes; the inception or deletion of retirement plan options, along with changes in the regulations which govern such accounts; and the introduction of lower-cost investment options for asset classes.
The table below shows the inception of various retirement plan schemes in the United States. If you change jobs, or experience income changes, your access to one or more of these type plans may also change. New plan types, which merit consideration, may also become available in the future.
| Retirement Plan | Inception |
| Traditional IRA | 1974 |
| SEP-IRA | 1978 |
| 401-k | 1978 -1981 |
| Thrift Savings Plan | 1986 |
| SIMPLE IRA | 1996 |
| Roth IRA | 1997 |
The table below shows the inception dates of the first index fund in the respective asset class. This process continues as low-cost index funds become available covering additional markets or market segments.
| Asset class | Index fund inception |
| S&P 500 | 1976 |
| U.S. total bond | 1986 |
| U.S. small-cap | 1989 |
| Pacific & Europe | 1990 |
| U.S. total stock | 1992 |
| U.S. REIT | 1996 |
Additional significant innovations in the investment markets include:
- In 1924, the first open-end US mutual fund was introduced.
- On January 1, 1975, US citizens could once again buy gold for investment purposes.
- In the US, 1993 marked the inception of the exchange traded fund.
- Tax advantaged 529 college savings plans became available in 1996.
- US inflation indexed bond securities were introduced in 1997 (Treasury Inflation Protected Securities) and 1998 (Ibonds).
Previous post in the investing basics series: Simplicity
Financial Page 