Risky Business
By Allison DeYoung, CFP®, CPA
We were all hit with a stark reminder in 2015 and the beginning of 2016 that stock markets don’t just go up. The fall of 2011 (4 years ago) was the last time we saw the US stock market drop by over 10%, a decline that is usually seen every 18 months or so. We can all agree it’s not a great feeling when you open your statement, and investment/401k balances are 10-20% less than they were the month before. Times like these present a great opportunity for investors, whether you invest on your own or if you use an advisor, to assess your personal risk tolerance and determine your plan of action—should you hold tight and do nothing, or rebalance to take advantage of some investments that are a better bargain than they were before.
Your personal risk tolerance defines your ability and willingness to stomach large swings in the value of your investments. This is an incredibly important aspect to investing and one that can substantially affect your returns over time. Markets can move quickly in both directions, understanding how you respond to market moves will start to help you determine how much risk you are comfortable taking in your investment choices to avoid making emotional decisions.
In general, the more you prioritize predictability the less you can prioritize opportunity or growth. Certain goals require more predictability than others, for example, if you’re purchasing a car next month, you likely want to prioritize predictability vs. if you’re looking to retire in 15 years, you need that money to grow to keep up with the cost of living. It’s important to understand the tradeoffs to risk—both positive and negative—and to be sure to set up your investment portfolio appropriately to ultimately reach your goals, whatever they may be.
Market volatility, both positive and negative, can represent opportunity. Let’s assume you’re invested in a portfolio that is appropriate for you in terms of risk assumed for your personal situation and to reach your long term goals. In a diversified portfolio, you likely have a couple positions that have done a little better than the others; for example, in a declining stock market, bond funds may steady returns. This is a time to take a look at the fundamentals of the market, the allocation of your portfolio, and see if this is a good time to purchase some attractive investments that are a better bargain than they were before the correction.
Additionally, in prolonged negative or positive markets, it’s important to continue to rebalance your portfolio to your appropriate allocation. A common long trusted concept comes to mind…buy and hold, but buy and hold doesn’t mean buy and forget. If you start out with a portfolio of 80% stocks and 20% income/alternatives and the stock market declines 50% and now without changing anything your portfolio breakdown is 40% stocks and 60% income/alternatives for the rebound. You took on 80% stock risk in the market decline and then just 40% stock risk in the recovery. This investor, making the correct decision not to sell into the decline, by not rebalancing, has a deck stacked against them in trying to recover losses.
Emotions affect everyone and no one is void of the tendency to make a bad decision when fear or greed gets the best of us. However, having a plan before these market moves is important to practically address your own emotions to help avoid making the wrong decisions for the wrong reasons. A plan won’t keep you from getting shaken and frustrated by market declines, but hopefully it will help you bring your practical self to the table to consider what can be done to take advantage.
