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"You Must Be Present to Win."© Sound Mind Investing | November 2010
The extreme market moves of the past three years (first down, then up) have caused investors much distress, prompting us to periodically reiterate the basics you need to keep in mind if you are to attain your long-term goals. Our core philosophy has four main components. First, recognize that the way you allocate your investments between equity investments (such as stocks) and interest-earning investments (such as bonds) is your single biggest investment decision. It has the greatest influence over your eventual results, and will likely determine how wild your investing journey will be. Second, that decision should be made based on factors that are personal to your situation: balancing your tolerance for risk 
Third, we recommend our Fund Upgrading strategy as your basic portfolio-building approach. Its track record over the past decade has been quite good, so it's time-tested. And it relies on specific, numerical guidelines, so it's methodical. This helps you minimize emotional decision-making. Our fourth point is short and sweet: stay the course. Many investors are fine with our prescription…until a bear market comes along. Then, many find the going too rough as the value of their portfolio falls more than they anticipated it might. To stop the emotional discomfort, they abandon their plan. Over the years, we've reported on several studies that we and others have done that are intended to mitigate the downside damage. We've reported on seasonal tendencies and election-year cycles All, however, are fallible. And all require investors to make periodic adjustments to their stock/bond allocations that can be difficult — not difficult to understand, but difficult to "pull the trigger" and actually implement the changes called for. For those investors, it's better to have a less than optimum stock/bond allocation that they can stay with long term than an allocation suggested by our "seasons of life" approach that they can't tolerate and stick with during down markets. The graphs at left pack a lot of information into a small space. Each measures the results from all the five-year periods from 1926 to the present time (I started with 1926 because that is as far back as the most commonly used historical performance data set goes). I selected five-year periods to learn what the short-term downside risk was for each of four different stock/bond allocations. As we would expect, the 100% stock portfolio had the best average result as well as the greatest number of home runs (41% of the periods tested showed gains of more than 100% during the five years). What risk-averse investors want, more than large gains, is to eliminate large losses. The 40% stock/60% bond portfolio had no five-year periods with losses of 25% or more. However, it did surrender a lot of upside potential. The 60% stock/40% bond portfolio seems to represent the "sweet spot" for risk-conscious investors — only 1% of the time did it suffer a serious loss, while it showed good-to-great gains in 69% of the five-year periods tested. Such a balanced approach might be just the ticket for nerve-racked investors. 
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