Setting realistic investing expectations is the only strategy a serious investor should use to build wealth. It’s about focusing on the long-term and reacting with a level head to the market conditions. If you are a veteran investor, you are probably already aware of this, but even then you may need to be reminded. And it’s especially true after the record-setting year 2013 was.
As we roll into 2014, it’s important we don’t expect 32% annual returns on our stock positions (that’s the return provided by the S&P 500 index, including dividends, during 2013).
This New Year could very well turn out to be a more “normal” year, as far as the stock market goes.
The year 2013 was so outstanding even a return to normal might seem like a dismal year. Once again, this is where setting realistic investment expectations becomes so very important.
Markets Don’t Always Rise So Be Ready
While we are contemplating the possibility of lower rates of return in 2014, this is also a good time to be reminded stock markets also fall. In fact, it’s quite common.
It just seems so unlikely when the market rises so relentlessly, as it has for the past five years. This is exactly why we need to be mentally prepared for a losing year.
Realistic expectations should not only include the possibility of a market decline, but also have you taking some of the following steps:
- Taking some profits
- Moving some capital into non-equity assets
- Emphasizing high dividend stocks
- Being mentally and emotionally prepared for a very different year in the markets
It’s not a matter of being pessimistic, it’s just what happens in the markets. Part of what will prepare you for a declining market is taking steps in advance to minimize potential damage, knowing you’ve done what you can to protect yourself.
The other part is keeping your expectations in line with a reality that may look quite different than the one we’ve known for the past few years.
Don’t Over-Fund Your Portfolio
Many investors load up on stocks at market tops, and take predictable beatings later. Realistic investing expectations should include spreading extra capital beyond your investment portfolio.
For example, paying off debt can give you a definite return on your money, one that can be even better than stock market returns in many years.
With this in mind, you may decide to pay off debt rather than putting more money in your portfolio. You may even decide to expand your emergency fund from say, 3-6 months of living expenses, to 12 months. This idle cash can have a way of steadying your nerves in the event the stock market goes on a wild ride.
It’s a matter of achieving financial balance in your life and not just pinning all of your hopes on your investment portfolio.
Adopt the View of Patient Capital
If the next year or two prove to be more volatile than the last five, you will have to seriously refocus on the long-term. Markets that consistently provide double-digit annual returns are easy on the nerves. Staying the course comes naturally. But if stocks begin to turn down — and they will eventually — thinking long-term will be a lot harder but even more necessary.
It’s at such times you need to be more focused on your long-term investment goals. Investing is largely a game of patient capital; you’re not chasing the next wave so much as building long-term financial security. Since there is no way to time the market with any accuracy, you need to be fully prepared to ride out the bumps along the way.
Expect a bad quarter or two, or even a bad year or two, and be prepared to ride it out. History has shown this to be the best strategy over the very long-term.
Go Beyond Your Portfolio
One of the dilemmas that often develops as a result of multi-year bull markets (especially record years) is investors start to imagine what if? As in, what if we continue to get 30% returns in the market for the next few years? I may be able take early retirement (travel the world, develop an investment course of my own, become a day trader…fill in the blank.)
Bull markets can do this to people, especially when they go on so long and so consistently. But when we start thinking this way, we’re leaving the realm of reality. In the real world, the stock market will not go up forever. You will experience declines, some of them protracted, and even a crash or two along the way.
For this reason, be sure you’re focusing on your life outside your portfolio. This includes the effort you’re putting towards your job or your business, your family, your health, and your personal satisfaction.
Oh, one other thing — don’t overspend. It’s a bad habit people develop during bull markets that can make life more difficult when the bull starts getting winded. Think of it as lifestyle diversification.
Let Go of Any Get-Rich-Quick Notions
Something of a gambler’s mentality can begin to set in during bull markets. The possibility of getting rich starts to seem achievable. Soon enough you start thinking you can even achieve it quickly. But there’s a fine line between successful investing and get-rich-quick, and you better make sure you understand where that line is.
Once you cross over into get-rich-quick territory, you could abandon common sense, and start getting reckless. This could play out by investing most or even all of your money in the stock market, and starting to think you can’t lose.
Get-rich-quick has nothing in common with serious investing. In fact, it’s mostly a distraction, and one with disastrous consequences.
It gets back to thinking long-term, which is the only strategy a serious investor should use. No matter what is happening in the moment, whether it is good or bad, you have to focus on the long-term goals.
This means finding and choosing your investments carefully, adjusting allocations when necessary, and always keeping realistic expectations about where your portfolio is headed.