Wells Fargo Investment Institute has identified four steps it believes will help investors meet their financial goals. In this report, it describes each of these steps.
1
Start with a plan
2
Construct a portfolio
3
Globalize the portfolio
4
Maintain alignment to the plan
The plan should be durable enough for the long term, yet stable enough to dissuade investors from abandoning it out of fear when times get tough. And while the plan should be flexible enough to accommodate major life changes, it should stay focused on the investor’s goals.
Determine financial goals
In developing a plan, an investor begins by identifying their financial goals. Each of these goals should be matched to a time when they will need the funds to accomplish the goal.
Build a rainy day fund for unexpected expenses
Starting with shorter-term goals means identifying how much liquidity, or readily accessible funds, an investor may need to cover day-to-day expenses should they experience an interruption in regular income or a significant unexpected expense.
We believe investors should set aside an amount of cash necessary to remain committed to their long-term investment plan. Some investors might consider one or two years’ worth of living expenses as a reasonable amount. For others, six to nine months’ worth of living expenses may be sufficient. Like the investment plan, the appropriate level of reserves is unique for each investor.
Select investments appropriate for the goal
With cash reserves set aside for emergencies, an investor can focus on intermediate- and longer-term goals. Keeping in mind the goals their investment plan is targeted to accomplish can help them decide which types of assets are appropriate for funding each of their goals.
Prepare for changing circumstances
An important consideration when choosing an appropriate mix of assets is risk tolerance. Determining how comfortable an investor is to look beyond short-term market dips and ride out bad times without abandoning their long-term strategy can also assist in determining risk tolerance.
Keep emotions in check
Human emotions, especially fear and greed, often do not lead to prudent investment decision-making. An annual study by Dalbar calculates the returns for average investors and compares them with the mutual fund universe and equity market returns.
Interestingly, it turns out the average retail investor fares much worse than the S&P 500 Index (see chart below). Dalbar attributes this result mainly to performance-chasing behavior, in which investors allocate more funding to assets that have done well recently and ignore those that have done poorly. They call this tendency the “investor behavior penalty”.
Attempting to time the market has proven costly
Investor returns have substantially lagged the markets, 1993-2022. 
Source: Dalbar, 30 years from 1993-2022. “Quantitative Analysis of Investor Behavior,” 2023, DALBAR, Inc., www.dalbar.com. For illustrative purposes only. Dalbar computed the average stock fund investor return by using industry cash flow reports from the Investment Company Institute. The average stock fund return figure represents the average return for all funds listed in Lipper’s U.S. Diversified Equity fund classification model. All Dalbar returns were computed using the S&P 500 Index. The S&P 500 Index is a market-capitalization-weighted index composed of 500 stocks generally considered representative of the U.S. stock market. The fact that buy and hold has been a successful strategy in the past does not guarantee that it will continue to be successful in the future. The performance shown is not indicative of any particular investment. An index is unmanaged and not available for direct investment. Total returns assume reinvestment of dividends and capital gain distributions. Past performance is not a guarantee of future results.
Source: Dalbar, 30 years from 1993-2022. “Quantitative Analysis of Investor Behavior,” 2023, DALBAR, Inc., www.dalbar.com. For illustrative purposes only. Dalbar computed the average stock fund investor return by using industry cash flow reports from the Investment Company Institute. The average stock fund return figure represents the average return for all funds listed in Lipper’s U.S. Diversified Equity fund classification model. All Dalbar returns were computed using the S&P 500 Index. The S&P 500 Index is a market-capitalization-weighted index composed of 500 stocks generally considered representative of the U.S. stock market. The fact that buy and hold has been a successful strategy in the past does not guarantee that it will continue to be successful in the future. The performance shown is not indicative of any particular investment. An index is unmanaged and not available for direct investment. Total returns assume reinvestment of dividends and capital gain distributions. Past performance is not a guarantee of future results.
Asset allocation can be the most important investment decision
Studies have shown asset allocation is often a crucial determinant of portfolio performance. The other factors shown in the chart below have proven to have much less impact on the variability of returns over time. While tactical asset allocation has a six- to 18-month time horizon, strategic asset allocation has a much longer horizon covering multiple market cycles. Strategic allocation, therefore, deserves considerable focus and effort.
Sources: “Determinants of Portfolio Returns,” Wells Fargo Wealth Management, November 2011; Morningstar Direct; Roger G. Ibbotson and Rex A. Sinquefield, “Stocks, Bonds, Bills, and Inflation: Year-by-Year Historical Returns,” University of Chicago Press Journal of Business (January 1976); Standard & Poor’s; and Wells Fargo Wealth Management.
Tactical asset allocation: Making of short-term adjustments to asset-class weights based on shorter-term expected relative performance.
Strategic asset allocation: An investor’s return objectives, risk tolerances, and investment constraints are integrated with long-term return assumptions to establish exposure to permissible asset classes.
Asset allocation, including strategic and tactical asset allocation, does not guarantee investment returns or eliminate the risk of loss.
Although many investors gravitate toward easily recognizable U.S. companies, building a globally diversified portfolio means adding appropriate levels of international assets. Many large, internationally based companies have become household names in the U.S. And historically, international stocks have benefited from a strengthening U.S. and global economy. We encourage investors to focus on the long-term positive outlook for global economic growth.
Emerging markets offer growth potential
Some exposure to faster-growing emerging markets can add another layer of diversification to a portfolio. As illustrated in the following chart, emerging markets contribute more to global economic growth than developed markets.
Emerging economies have overtaken developed economies
The percentage of global GDP contributed by emerging economies eclipsed that from developed economies several years ago.
Sources: International Monetary Fund (IMF) and Wells Fargo Investment Institute, as of December 31, 2022. GDP=gross domestic product.
Rebalancing can help manage risk
A change in economic conditions or large market moves, upward or downward, can significantly alter a portfolio’s risk/ reward profile. A constructive way to realign a portfolio is to periodically trim those asset classes that have grown beyond target levels and invest in those that have dropped below target levels to bring the allocation back to its original targets. This is an effective version of the “buy low, sell high” principle.
Stay the course
While it is important to design a solid plan and then implement it using the right mix of assets and proper diversification, these efforts may be all for naught if an investor is unable to adhere to the plan.
Periodically reevaluate your investment strategy
Milestones such as getting married, buying a home, starting a family, supporting a child through college, and retirement are just a few examples of significant life changes. As major life events approach, this offers an opportune time to reevaluate investment goals and determine whether any changes to the overall investment strategy are warranted.
Turning points that can affect an investment plan for individuals in their:
Examples are for illustrative purposes only and may not reflect an individual’s own experience.
Source: Wells Fargo Investment Institute
Develop an investment plan
A well-constructed investment plan based on an investor’s unique circumstances that is rebalanced regularly can help alleviate anxiety over market uncertainty. This can be especially helpful during periods of heightened volatility that we expect from time to time in normally functioning markets.
Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Diversification cannot eliminate the risk of fluctuating prices and uncertain returns.
Equity investments: Stocks offer long-term growth potential but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Fixed income: Investments in fixed-income securities are subject to interest rate, credit/default, liquidity, inflation, prepayment, extension, and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in a decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and/or principal. High-yield fixed-income securities (junk bonds) are considered speculative, involve greater risk of default, and tend to be more volatile than investment-grade fixed-income securities. If sold prior to maturity, fixed-income securities are subject to market risk. All fixed-income investments may be worth less than their original cost upon redemption or maturity.
Foreign investments: Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
An index is unmanaged and unavailable for direct investment.
S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value-weighted index with each stock’s weight in the index proportionate to its market value.
Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
The information in this report was prepared by the Global Investment Strategy (GIS) division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector, or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold, or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs, and investment time horizon.
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