4 things every long-term investor should know

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Understanding your risk tolerance, staying the course, diversifying your investments and keeping your goals in sight can help you weather the market's inevitable ups and downs.
Every time the market drops dramatically, some investors begin to wonder: Would I be better off in cash? "Even in strong markets, there are usually days and even weeks that can test an investor's mettle," says Nick Giorgi, investment strategist in the Chief Investment Office for Merrill and Bank of America Private Bank. "But you shouldn't lose sight of what you're investing for." He continues, "Whatever the markets do, the following best practices can help you avoid costly pitfalls as you work toward reaching your financial goals."

1. Understand your comfort level with risk

When you commit your money to financial markets, it's important to keep in mind that risk is involved, says Giorgi. Temporary market declines happen quite often, even during periods when stocks are mostly rising.
It also helps to recognize that there are different kinds of risk. Buying stocks exposes you to market risk — the chance that share prices will fall and your investments will be worth less than their original price. Bonds tend to be somewhat less volatile than stocks, but they come with other potential risks. These include credit risk, the possibility that a bond issuer could fail to make interest payments and return your principal, and interest rate risk, the chance that interest rates could rise while you hold your bonds and reduce their value.
"Understanding how much risk you're comfortable taking on and aligning your investments to your risk tolerance can help you come to terms with periodic volatility," says Giorgi, who notes that it's crucial to try to avoid hasty, emotion-driven moves that could have long-term consequences. "If you sell at market lows, you could lock in losses," he says. "And if volatility drives you to excessive caution — say, by making you want to keep your money in cash — that may feel reassuring, but it could mean that you might miss the opportunity for potential future gains."

2. Avoid the temptation to time the market

If you know a market setback is likely to come sooner or later, you might think the solution is to pull your money out of the market just before prices fall. But spotting market downturns in advance is extremely difficult — and the stakes of not staying invested can be high. "If you jump in and out of the market, you'll almost inevitably find yourself on the sidelines when prices push higher," Giorgi says. "And you could also miss out on dividends, share buybacks and interest payments that may continue even amid periods of volatility."
If you jump in and out of the market, you'll almost inevitably find yourself on the sidelines when prices push higher. And you could also miss out on dividends, share buybacks and interest payments that may continue even amid periods of volatility.
— Nick Giorgi, investment strategist in the Chief Investment Office,
Merrill and Bank of America Private Bank
In addition, big returns can happen on relatively few trading days, raising the stakes of a mistimed market exit. For example: An investor who missed the 10 best-performing days of the S&P 500 since 2010 would have seen returns of 95% versus the 190% gain they might have earned had they remained in the market during those 10 days.Footnote 1
Graphic showing a series charts illustrating how missing the S&P 500's 10 strongest days in any decade could have a dramatic effect on cumulative returns. The text at the top of the graphic reads, "The Best Days Make a Big Difference." Underneath, there is a comparison of two charts showing the overall returns if you missed the 10 best days per decade in the S&P 500. If you missed those days since 2010, your overall returns would be 95%. If you missed those days since 1930, your overall returns would be 91%. If you didn't miss the 10 best days per decade since 2010, your overall returns would be 190% and if you didn't miss the 10 best days per decade since 1930, your overall returns would be 14,962%. The graphic also clarifies that the returns shown are cumulative returns either including or excluding those 10 best days. Disclaimer: Past performance does not guarantee future results. Source: BofA Global Research. Data as of June 8, 2020.
In some cases, the longer you hold an investment, the more potential there is to see positive returns. That can be truer of equities, which can be unpredictable and volatile over shorter time periods, but have done well historically over the long term.Footnote 2 "You can use time in the market — as opposed to timing the market — to your advantage," Giorgi says.

3. Embrace diversification

Building a portfolio with a mix of different assets — stocks, bonds and cash — can help you balance the overall risk level of your investments. In the short term, the overall return of a diversified portfolio may be less than what you'd see from a small group of assets that are doing well at that moment. But those moments rarely last. "Over longer periods, proper diversification can help even out your returns, so that some of your assets can potentially be gaining value as others may decline," Giorgi says.
Over longer periods, proper diversification can help even out your returns, so that some of your assets can potentially be gaining value as others may decline.
— Nick Giorgi, investment strategist in the Chief Investment Office,
Merrill and Bank of America Private Bank
But diversifying isn't enough. As markets shift, your allocation to certain asset classes can expand or shrink, and you'll want to bring them back in line with your goals and timelines. One best practice useful in helping to maintain a chosen level of diversification is regularly reviewing and, if necessary, rebalancing investments, Giorgi adds. Say, for instance, that you've allocated 60% of your portfolio to equities. After a particularly good year in the markets, equities could represent 75% of the value of your portfolio, and you may want to make adjustments to bring equities back in line with your chosen allocation.

4. Stay focused on your goals

Your willingness and ability to tolerate various kinds of risk are likely to evolve over time, as will your goals — the priorities you're investing for. That's another major reason to rebalance your portfolio periodically. But as you do, it's important to continue to make decisions thoughtfully, keeping the principles of long-term investing firmly in mind.
Investors committed to leaving their money in the markets for the long term frequently employ certain basic strategies to help them meet their goals, such as reinvesting the dividends their stocks earn and dollar-cost averaging (or the process of investing small amounts on a consistent basis over time). Investing a fixed dollar amount on a regular basis — say, for instance, by setting up automatic deductions from your paycheck — can help you avoid investing too much when the market is high and too little when the market is low.
"Knowing why you've chosen the investments you have and how they help you manage risk can increase the likelihood that you'll stay disciplined amid changes in the markets and your life," Giorgi says. "Then by revisiting your mix of assets and rebalancing as needed, you can continue to give yourself the potential for success."
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The Chief Investment Office, which provides investment strategies, due diligence, portfolio construction guidance and wealth management solutions for Global Wealth & Investment Management ("GWIM") clients, is part of the Investment Solutions Group ("ISG") of GWIM, a division of Bank of America Corporation ("BofA Corp.").

Footnote 1 BofA Global Research. Data as of June 8, 2020.

Footnote 2 BofA Global Research. Data as of June 8, 2020.

Investing involves risk. There is always the potential of losing money when you invest in securities.

Opinions are those of the author and may not be appropriate for all investors and may be subject to change.

Asset allocation, diversification, dollar cost averaging and rebalancing do not ensure a profit or protect against loss in declining markets.

Keep in mind that dollar cost averaging cannot guarantee a profit or prevent a loss in declining markets. Since such an investment plan involves continual investment in securities regardless of fluctuating price levels, you should consider your willingness to continue purchasing during periods of high or low price levels.

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