When markets go through downturns such as the beginning of this year, or Brexit, or even 2008, how likely are you to want to sell your investments and “just get out”? Or do you accept that markets go up and down and this may be a down moment? Investment resilience is tested in the face of unsettling news. How do you improve it?
Here are some ways to examine your resilience awareness and improve your response to risk.
Understand Risk/Reward Trade Offs
A good risk tolerance questionnaire is good place to start. You might want to revisit it every few years, as your tolerance will change in different circumstances through your life. (Ask us for ours if you want to see where you’re at).
Keep in mind there is a price in being too conservative.
Take a 40-year-old woman who has $100,000 and hopes to accumulate $1,000,000 by age 65. Based on historical returns, she would need to save $7,000/year if her portfolio is 100 percent in stocks/equities. If she has a balanced portfolio, she would need to save about $12,700/year. If she is 100% in bonds, she’d need to save more than $24,000 a year. If that $100,000 was in a money market fund, or in high interest savings at the bank, she would need to save $33,000 a year.
Create a worst-case scenario
What’s your worst portfolio nightmare? Losing 30 percent, 50 percent? Losing $50,000 or more in a day? How would that change your ability to meet your goals – a comfortable retirement or funding your kid’s education?
Become aware of your limits. Your portfolio should reflect the risk that you can live with across market cycles, and you need to be aware of the corresponding reward that pairs with that risk. That way, you can better resist the knee-jerk reactions to volatility. Staying in the market through market gyrations has big payoffs.
If you don’t believe me, read this.
Connect your Investments to Short/Med/Long Term Goals
Divvy up your assets into short, medium and long term buckets to correspond to various goals.
The short term bucket might be enough for you to live on for 6 months or to buy a car or house within a couple of years. These investments should be low risk (unfortunately with the corresponding low return). The medium term goals could be balanced with medium risk stocks and bond. The longer term bucket can be more growth-oriented, with the awareness that the volatility will be greatest.
A few people also have a “play” bucket for speculation. That is for those who do not need those funds for anything else. You need to recognize that if those funds went to $0, your life would not be materially changed.
An aside: We commonly see Tax Free Savings Accounts used for the short term bucket or emergency fund, where the tax-free part is largely being wasted. For the vast majority, it is the perfect account for the growth oriented bucket.
Repeat after me: Volatility is normal. Volatility is normal…
The “normal” market state is volatile, not calm. There will be down years and market crashes. The key is to be positioned so that you can ride it through and not sell at the wrong time.
The problem is that risk tolerance changes with the market. People overstate their risk tolerance in up markets and reduce it in tough markets.
This is why it is important to evaluate your tolerance in those tough times, but make the adjustments to your portfolio in better times.
Remember: Market Timers usually lose
Morningstar does a study every year to track how the average mutual fund investor’s returns differ from the average mutual funds returns. In its 2015 report, Morningstar found that the average returns for the time investors owned a fund trailed the actual performance of the fund by about 1.32 percent on average. In other words, investors tend to buy high when everyone is enthusiastic and sell low when they are fearful.
Overall, you need to be comfortable with your portfolio and aware its associated risks. Know also, that this will change and you need to adjust every so often as you go through life.