Now that winter is almost here, you probably see “Flu Shots Available” signs at many of your local pharmacies. Whether or not you decide to get a flu shot depends on your individual situation, of course, but you may benefit from the idea of immunization in other areas of your life — such as your investments.
Specifically, you may want to help “immunize” your portfolio, as much as possible, against some of the volatility we’ve seen in the financial markets over the past couple of years. How can you do this? Here are a few suggestions:
•Diversify, diversify, diversify. If you were to only own stocks, your portfolio would, at times, see some big gains — but at other times, you’d take some big hits. If you just owned bonds, you’d probably see fewer fluctuations than if you just owned stocks — but you’d almost certainly never get the gains you need to help achieve your goals. If you kept all your money in cash instruments, you’d protect your principal, but you’d eventually lose ground to inflation. In short, you can’t succeed as an investor by putting all your money in one type of asset. You need to spread your resources among stocks, bonds, and cash investments. And even within each of these categories, you need to diversify. For example, try to own a mixture of growth stocks and income-producing stocks; short-term and long-term bonds; and a variety of cash instruments. While diversification, by itself, can’t guarantee profits or protect against loss, it can give you opportunities for potential success and help shield you from severe downturns that, at any given time, primarily affect just one asset class.
•Know your risk tolerance. If you frequently find yourself surprised, or perhaps dismayed, at the fluctuations in your portfolio, you may be overestimating your risk tolerance. If you familiarize yourself with your investments before you buy them — and you should — then you probably shouldn’t be surprised at how they perform. So, if you own growth-oriented stocks, you need to accept the inevitable short-term volatility in exchange for potential gains over the long term. But if you’re constantly worried over temporary setbacks, you may be taking on too much risk for your comfort level. If this happens, you may need to rebalance your portfolio to better accommodate your true risk tolerance.
•Maintain adequate cash reserves. Having sufficient cash in your portfolio can help you combat volatility in at least two ways. First, since cash essentially doesn’t fluctuate in price — though it may lose value over time, relative to inflation — its very presence can help stabilize your portfolio. And second, if you have enough cash in your investment mix, you may be less likely to dip into your long-term investments to pay for short-term needs, such as a major car repair, a new furnace and so on — and the less you disrupt your investments, the more progress you can make toward your goals.
It’s not possible to fully shield your investments from volatility all the time. But by taking the steps described above, and by maintaining a long-term perspective, you can strengthen your portfolio’s resistance, and improve your own responses, to the effects of price fluctuations. And that’s a healthy way to invest.