9 Be diversified: We own stocks and bonds and real estate and commodities (pretty much in that order). When one market or asset class is falling, others tend to go in the opposite direction. We also own a broad variety of equities: There is geographic variation, differing market-capitalization sizes and economic sectors. Diversification usually means that different asset classes behave differently. When equities get shellacked (like this past week), bonds tend to rally. (It was reversed last month: Stocks rallied, bonds sold off).
A balanced portfolio approach tends to underperform markets on the way up but suffer much less on the way down. The goal is to allow you to pursue your financial goals but still sleep at night.
10 Understand your time line: People have a foolish tendency to lose sight of the long term in the midst of the day-to-day noise.
Most of you have an investing timeline between 10 to 40 years. (If you plan to start withdrawing money to live on in 10 years or less, you will need to be more conservative). But those of you in your 20s, 30s, 40s or even early 50s have a much longer time horizon. Secular (or long-term) bear markets are to be expected, and they let you buy advantageously if you can overcome your own instincts. Volatility and short-term market swings are part of the nature of markets.
When your investing timeline is measured in decades, you cannot afford to continually miss an ongoing rally because of day-to-day volatility.
Markets that rally 150 percent come along once a generation. If you missed this one, it is probably because you based your investing on some form of guess as to what stocks were going to do. Experience teaches us that we are all pretty bad at making forecasts nearly all of the time. This is why any prediction-based investment strategy is doomed to failure. The outcome is binary: Your guesses are either right or wrong.
Consider instead a probability-based investment approach. The idea behind asset allocation is to allow mean reversion, rebalancing and diversification to work in your favor. No guesswork required.
Ritholtz is CEO of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Follow him @Ritholtz.