The market’s recent extreme swings offered investors a great chance to re-check their personal risk tolerance. If you found the volatility too much to bear, you should seriously consider lowering the risk in your portfolio.
A key factor in designing an investment mix is a person’s risk tolerance. Typically, younger investors should have a higher level of stocks relative to bonds, because they have a longer time horizon for stock prices to bounce back from periodic declines, and because they need less of the current income bonds generate.
But everyone is different, and age alone is not enough to determine if you have the right mix.
Getting the right risk level is critical. For example, if you sell shares in a panic after a 20% drop, you will have lost that 20% forever. The stock market inevitably rebounds at some stage, so if you don’t sell (or if you buy more when they’re down), you’ll likely make up the losses, and more, over time. But if you move to cash or bonds, it may take many years to recoup the money. Better not to have owned the shares to begin with.
If you couldn’t sleep during the recent turmoil, make a plan now to gradually reduce the percentage of stocks in your investment mix. Remember, however, that your more conservative posture has a downside: you will probably have lower returns long-term. So check your financial plan. If the new expected return doesn’t allow you to pay for retirement or other key goals, you may want to scale back those expected expenses.
If, on the opposite extreme, you like to buy aggressively during a big drop, think about adding more stocks to your portfolio. If you welcome risk, you’ll probably benefit, long-term, with higher returns. Warren Buffett has been doing that recently. Of course it’s easier when you have his resources, but the logic holds.
Re-assessing your risk comfort level is worth doing periodically anyway, but there’s no
better time than when a sharp sell-off is fresh in your mind. Sooner or later, another drop will come, and you’ll be much happier if your portfolio and your psyche are ready.