In the late 1990s, many investors enjoyed the fruits of positive double-digit returns with their equity investments. Then, during the period of January 1, 2000, through December 31, 2002, the S&P 500 lost more than 40% of its value, and so did the portfolios of many investors. Then, a similar cycle repeated itself again, ending in a market crash in 2007-2008. Such volatility can be disturbing to portfolio performance and ignite fear in investors. However, history has shown that financial markets will reward investors for the capital they supply over the long term.

If you understand all the different types of accounts available and implement a disciplined investment strategy you will increase your chances of success. Do you have a written monthly budget? What is your discretionary income. With pension plans disappearing and Social Security on the rocks, we will show you what you need to do to succeed in achieving your financial goals.

Understand Your Investments

In order to enhance your investment returns, it’s important that you understand the fundamentals of equity (stock ) and fixed-income (bond ) investments. (To learn the basics of investing, see Investing 101: A Tutorial For Beginner Investors .)

Three Equity Factors

1. Equities (stocks) have had historically higher expected returns than fixed-income investments (bonds).
2. Small company stocks have higher expected returns, but higher volatility, or risk, than stocks from large companies. (To read about portfolio risk, see How Risky Is Your Portfolio? )
3. Lower priced value stocks have higher expected returns than higher priced growth stocks. Many economists believe small cap and value stocks outperform because the market rationally discounts their prices to reflect underlying risk. The lower prices give investors greater upside as compensation for bearing this risk. (To learn more about this topic, read Risk And The Risk Pyramid and Working Through The Efficient Market Hypothesis .)

Two Fixed Income Factors

1. Longer term instruments are riskier than short-term instruments due to the longer exposure to interest rate risk .

2. Lower credit quality issues are riskier than high credit quality issues, but offer a higher rate of return if there is no default.

Diversification

Diversification is a strategy that can be summed up by the timeless motto, Don’t put all your eggs into one basket. The strategy involves spreading your money among various investments in the hope that if one investment loses money, the other investments will make up for those losses. The key to a well diversified portfolio is to allocate your assets with mindset that negatively correlated assets help reduce risk. (To read more about diversification, see Modern Portfolio Theory: An Overview . Introduction To Diversification . The Importance Of Diversification and A Guide To Portfolio Construction .)

What do we mean by negative correlation in a portfolio? This is the process of finding asset classes that perform differently. For example, commodities tend to perform differently than the S&P 500, and real estate investment trusts (REITs) tend to perform differently than the Dow. By mixing these types of asset classes in your portfolio, you enhance your chances of making money when U.S. markets are underperforming.

The U.S. stock market is presently less than half the size of the total world stock market, so if you’re not investing internationally, you could be missing out on some great investment opportunities. Determining the perfect amount of money to allocate to the different asset classes is the tricky part.

Asset Allocation

Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, alternative investments and cash. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk. (To find out more about asset allocations, see Five Things To Know About Asset Allocation . Achieving Optimal Asset Allocation and Asset Allocation Strategies .)

A Brinson, Hood and Beebower 1986 paper entitled ed Determinants of Portfolio Preference analyzed quarterly return data of 91 large pension funds over the period 1974 to 1983. Its main conclusion was that 94% of the variability of total portfolio returns is explained by strategic asset allocation, with security selection and market timing playing minor roles, although many active stock managers tend to challenge this study.

All investments have some degree of risk. In an investor’s portfolio, risk is typically measured by using a number referred to as standard deviation. The more risk that you are willing to absorb in your portfolio, the greater the potential for a higher return. When you determine an acceptable level of risk for your situation, you can then work on developing your asset allocation. You can use the standard deviation associated with specific asset class indexes to get a feel for the amount of risk your portfolio will assume. When your asset allocation is in place, consider annual or semiannual rebalancing. Rebalancing is bringing your portfolio back to your original asset allocation mix. This is necessary because over time, some of your investments may become out of alignment with your investment goals. (To explore rebalancing further, see Rebalance Your Portfolio To Stay On Track and New Year’s Resolutions To Improve Your Finances .)

Final Thoughts to Help Enhance Wealth

1) Seek out Dividends

Volatility of the markets causes stock prices to rise and fall, but income is generally positive. If you seek out income-producing investments such as bonds, money market funds, high-dividend -paying stocks and income trusts. you can protect your portfolio during market declines. Because companies don’t like to cut or reduce their dividends unless it is in the direst circumstances, a dividend is paid to you whether the stock price is rising or falling.

2) Implement Dollar-Cost Averaging