Greetings! I hope and trust that this finds you well and enjoying life.
In light of the fact that we are in the ninth year of the bull market and last years advances, I felt it might be useful for readers to consider the following information.
How much risk can you handle? In other words, how much risk can you take on in your investments and still sleep at night? Many market shocks are short lived once investors conclude the event is unlikely to cause lasting economic damage. Still, major market downturns such as the 2000 dot-com bust and the 2008-09 credit crisis are powerful reminders that we cannot control or predict exactly how, where, or when precarious situations will arise.
Market risk refers to the possibility that an investment will lose value because of a broad decline in the financial markets, which can be the result of economic or socio-political factors. Investors who are willing to accept more investment risk may benefit from higher returns in the good times, but they also get hit harder during the bad times. A more conservative portfolio generally means there are fewer highs, but also fewer lows.
Your portfolio’s risk profile should reflect your ability to endure periods of market volatility, both financially and emotionally. Here are some questions that may help you evaluate your personal relationship with risk.
How much risk can you afford? Your capacity for risk generally depends on your current financial position (income, assets, and expenses) as well as your age, health, future earning potential, and time horizon. Your time horizon is the length of time before you expect to tap your investment assets for specific financial goals. The more time you have to keep the money invested, the more likely it is that you can ride out the volatility associated with riskier investments. An aggressive risk profile may be appropriate if you’re investing for a retirement that is many years away. However, investing for a teenager’s upcoming college education may call for a conservative approach.
How much risk may be needed to meet your goals? If you know how much money you have to invest and can estimate how much you will need in the future, then it’s possible to calculate a “required return” (and a corresponding level of risk) for your investments. Older retirees who have sufficient income and assets to cover expenses for the rest of their lives may not need to expose their savings to risk. On the other hand, some risk-adverse individuals may need to invest more aggressively to accumulate enough money for retirement and offset the risk of inflation which erodes the purchasing power of your assets over the long term.
How much risk are you comfortable taking? Some people seem to be born risk-takers, whereas others are cautious by nature, but an investor’s true psychological risk tolerance can be difficult to access. Some people who describe their personality a certain way on a risk profile questionnaire may act differently when they are tested by real events.
Moreover, an investor’s attitude toward risk can change over time, with experience and age. New investors may be more fearful of potential losses. Investors who have over time experienced the cyclical and ever-changing nature of the economy and investment performance, may be more comfortable with short-term market swings.
Brace yourself. Market declines are an inevitable part of investing, but abandoning a sound investment strategy in the heat of the moment could be detrimental to your portfolio’s long-term performance. One thing you can do to strengthen your mindset is to anticipate scenarios in which the value of your investments was to fall by 20% to 40%. If you become overly anxious about the possibility of such a loss, it might be helpful to reduce the level of risk in your portfolio. Otherwise, having a plan in place could help you manage your emotions when turbulent times arrive.
If you have questions about any of the above or feel that we can help in any way don’t hesitate to contact us.
Jeff Christian CFP, CRPC
Your talent is God’s gift to you. What you do with it is your gift back to God.