The right investment strategy is so much more.
When it comes to investing there are generally two schools of thought. The first being "Active" management, which involves picking and choosing the stocks, bonds or funds that you think will perform the best overtime. Then there is a "passive" or "Buy & Hold" strategy which advocates purchasing index funds and leaving the portfolio alone to grow over time. All of the research shows a passive investment strategy will win out over time when compared to an active stock picking strategy. However, is Buy & Hold really the best strategy?
Let's just say its a good start but not sufficient. This is because of three main reasons.
1) Markets Move and cause your asset allocation to change over time. For example if you determined that your appropriate asset allocation is a 60% stock portfolio and a 40% bond portfolio you need to make sure it stays somewhere close to that allocation. If we are in the middle of bull market your allocation could easily increase to an 80% stock allocation over time because the value of the stocks in the portfolio have grown significantly. Your portfolio is now much riskier then you originally planned. Therefore, at the very least, you should rebalance your portfolio from time to time to account for these changes; ensuring your allocation is still appropriate given your circumstances.
2) Taxes - You can add significant value to your portfolio by harvesting losses when the market is down. This just means you sell a stock or fund for the sole purpose of "banking" a loss which you can use later to offset any capital gains or up to $3,000 in ordinary income. Part of this goal is to maintain the same asset allocation as before once the transaction is complete. This is done by simultaneously selling your fund with the loss and buying another similar fund. (check out this list of S&P 500 Index Funds for examples of similar Large US stock funds) By doing this on a regular basis you can add significant value to your portfolio's after tax rate of return. You can also be harvesting gains when appropriate - see our blog post on High Net Worth Withdrawal Strategies.
3) Life Changes - Any good investment plan should be based on certain assumptions such as age, income, marital/familial status and most importantly your goals. The third problem with a buy and hold strategy is that is doesn't account for any changes in your financial plan. There are many things that would change the way you invest your portfolio. Let's say there is a disability in the family, your tolerance to take risk would dramatically decrease and your portfolio should be reallocated to reflect this. Or what happens when it comes time to start drawing on the portfolio for retirement income? Your asset allocation becomes critically important during this time and a simple buy and hold strategy just won't cut it.
While buy and hold is tempting because it's so simple, you need to be more active in the management of your investments even if those investments are passive in nature. The key to a successful investment strategy is buy, hold, rebalance, and tax manage. Then on a regular basis revisit the assumptions that underlie your financial plan.
Of course, for additional help with your investment strategy or financial plan you can contact a Phillip James Professional.