Practical Steps to Improve Your long term Investment Strategy

Investing in the stock market can feel like a rollercoaster of emotions—it’s no secret that most people are motivated by fear or greed. But this just the tip of the iceberg when it comes to understanding our investment decisions. Having worked directly with clients as a financial planner, I’ve seen firsthand how emotions and misunderstandings about risk can impact investment success. In this article, we’ll break down what it really means to manage risk, how to build a long-term investment focus, and why becoming financially literate is the first step toward achieving your financial goals.

Beyond the Suitability Calculator

Some of us may be familiar with a suitability calculator Investment advisors use to help determine the appropriate mix of cash, fixed income, and equity we should hold. essentially it gauges how much volatility we are comfortable with in our portfolios, with equities being the most volatile. Many clients express frustration with completing a risk tolerance questionnaire, asking, “What if my mood or risk appetite changes tomorrow?” highlighting a flaw of the tool as investors be grouped into static risk profiles almost like a horoscope sign. While the financial services industry takes the result of the questioner as something fixed which informs their recommendations to the client.

Here is a link if you want to give it a try :

https://www.ciro.ca/office-investor/understanding-risk/investor-questionnaire

Stocks vs. Bonds: The Long-Term Growth Potential of Equities

A bond is a fixed-income instrument and investment product where individuals lend money to a government or company at a certain interest rate for an amount of time. The entity repays individuals with interest in addition to the original face value of the bond.

A stock, also known as equity, is a security that represents the ownership of a fraction of the issuing corporation. Units of stock are called shares, which entitle the owner to a proportion of the corporation’s assets and profits equal to how much stock they own.

It is assumed that cash and fixed income provide safety. However, this "illusion of safety" because of low volatility can be costly in the long run as data shows you wont keep up with your principals purchasing power over time.

Developing Financial Literacy for Better Investment Decisions

The stock market is volatile in the short term, making equity such as stocks seem risky. But if you invest for the long term, that is, more than 10 years, history shows that down markets have almost always been more than offset by up markets, giving reliable returns for stocks after inflation. In fact Inflation makes bonds riskier than stocks over the long term.

Over the last 150 years, the S&P 500 and other major indices have rebounded consistently from recessions and market crashes. This resilience underscores the value of a long-term, diversified investment strategy. How long you can invest for is critical in determining the right asset mix of for you. If you only have a few years to invest, then most of your money should be in fixed income type assets. If you have investments designated for goals five to 10 years or more from now, you need to consider investing more of those funds into equities.

While downturns can be discouraging, the stock market’s history of recovery highlights the potential for gains with patience and strategic planning. Most of us are at least 20 years from retirement and will continue to invest even in retirement. Holding an inefficient asset allocation can mean needing to work harder to fund your goals and increases the risk of falling short.

The graph shows 100 years of growth in stocks vs. bonds in “real” dollars, after adjusting for inflation . If you started with $1,000 in each, you would now have over $2.2 million with stocks, but only about $9,000 with bonds.

Recently, I came across financial planner Ed Rempel, who inspired me to write this blog of the idea that risk tolerance is a skill that can be actively developed. Reflecting on my own journey, I realized that I, too, have gradually increased my own risk tolerance through experience and ongoing education. In working with clients, I've applied similar principles, often without consciously labeling it as

Risk assessment tools measure what’s called "behavioral risk," or the likelihood that an investor will sell assets during a market decline. However, it’s important to remember that the market has never dropped to zero. Over time, equities tend to outperform other assets, meaning that, despite inevitable downturns, a long-term approach to investing in equities has historically produced stronger returns. For anyone investing with a long-term horizon, understanding this perspective is essential.

Improving financial literacy can transform an investor’s approach to risk. By deepening our knowledge of markets, asset classes, and behavioral finance, we can develop confidence and a long-term perspective that enable us to manage risk wisely. Over time, this knowledge builds a resilient mindset, allowing us to handle higher risk as a means of achieving greater potential returns.

How Fear and Greed Drive Market Decisions (And What You Can Do About It)

In the short-run, there is much we cannot control, so the wise approach is to focus on what we can. When we choose well-diversified, quality equity funds rather than speculative ones, we accept that short-term volatility is inevitable. This volatility often stirs intense emotions, amplified by what is known as the 'Herd Mentality'—the tendency to let emotions drive decisions, a common mistake many investors make without realizing it.

The graph below illustrates the typical emotions experienced at each phase of a recurring market cycle.

Exploring the Emotions Behind Investment Decisions

Fear: This is a natural reaction to perceived threats and can lead to impulsive decisions, like selling assets in a market downturn.
Greed: This involves an excessive desire for wealth, often driving individuals to take high risks in pursuit of greater returns without fully considering potential downsides.

By understanding these drivers, we can cultivate their opposites:

Confidence: With knowledge and a clear long-term focus, investors can remain calm and make informed decisions rather than reacting to temporary market losses.
Prudence and Contentment: These qualities counterbalance greed, promoting sustainable, cautious growth rather than impulsive, short-term gains.

A financially literate and emotionally balanced approach to investing, with a long-term perspective, helps investors harness the power of the stock market for maximum growth. By learning to manage our emotions and understanding both the opportunities and risks in investing, we can make more effective financial decisions and confidently move closer to achieving our long term goals.

Reference:

Morningstar- https://www.morningstar.com/features/what-prior-market-crashes-can-teach-us-in-2020)

https://edrempel.com/investment-risk-that-affects-your-life-vs-investment-industry-risk/