Risk tolerance, how much your psyche can withstand when large swings in the stock market jeopardize the value of your investments, is an important component of investing.
It is a fact of life that all investments can lose value. In the normal course of trading, up and down swings are expected. Market volatility – the inevitable ups and downs of the market – is the rise and fall more of than one percent over a sustained period of time and is inherently associated with big swings in either direction; an inevitable part of the journey.
Because markets are forward-looking, they are accustomed to bad news and typically shrug it off. But make no mistake, markets do not like bad news or uncertainty. Investors don’t either. How about your risk appetite? How many different kinds of risks are you willing to take to achieve your objectives?
The Higher the Risk, the Riskier the Security
Risk in moderation is not a bad thing. What some people call “risky” often makes them money—and making money is the reason for taking the risk. If you’re unwilling to take the risk that an investment’s value might drop in value, you have little to no risk tolerance.
Realistically, your risk tolerance reflects your personality and how you react to things. Depending on what you and your advisor have determined to be your end goal, remember there are good fixed income alternatives for you and your risk tolerance.
Bond prices, for example, are affected by supply and demand, market sentiment and economic environments. When sentiment is bullish, stocks are on the rise and investors generally move out of fixed income and into stocks. When sentiment is bearish, stock prices fall and investors move back into bonds. Understand that the rate of return is lower than other investments, but bonds are generally safer than stocks and should occupy a percentage of your overall portfolio.
“Some” Risk is Subjective
If you can handle some risk with investments that fluctuate, you have a greater risk tolerance. The concern behind limiting your investment risk with bonds is you become vulnerable to inflation risk, interest rate risk, possible credit risk or loss of buying power. However, you shouldn’t jump in and out of the market whenever you get nervous.
What some people will do when the Dow Jones Industrial Average is down 600 points on a given afternoon is contemplate selling— panic selling— when stock prices rapidly decline on high volume. This happens when short-term traders are able to force the stock price down far enough to trigger long-term stop-losses. Understand though, panic selling is never a good strategy. Investors who stayed the course during the financial crisis ended up recouping all of their losses while also participating in the longest-running bull market in history. Of course, past performance is no guarantee of future results either.
With a disciplined, long-term approach to both financial planning and investment planning, over time you will deal with bad news more effectively and have less to worry about thanks to confidence gained from previous experiences.
A Good Asset Allocation Program is a Component of a Successful Financial Plan
The longer you participate in the markets, the more likely it is your personal risk tolerance may undergo changes. For example, risk tolerance tends to decline with age and increase with improvements in macroeconomic conditions like supply chain issues and pandemics.
Clearly, you should have arrived at a realistic understanding of your preparedness and capacity for large market swings. Your expectations are better handled. In turn, you can better handle turbulent times during sell-offs and troubled times, adding more personal money to investments when prices are low and everything is “on sale.”
When going through rough market cycles, your Hefren-Tillotson advisor will help you understand when and why it’s important to go into defensive mode, given the asset allocation parameters, and when to return to normal or offensive allocation mode, given your particular financial plan and risk tolerance.
Oftentimes, for retired individuals it is not about a rate of return they’re getting; it’s about drawing income as needed. Daily changes in the markets typically have no bearing on this income. However, that is not to say that market swings go unnoticed.
Spending, in relation to assets, is problematic during market volatility – that is, spending ramps up while assets decrease in value. When spending is slightly out of control, Hefren-Tillotson advisors remind their clients what the parameters are, based on their asset level, to avoid running into real trouble later on.
Does Your Portfolio Match Your Goals?
Your annual review is a good time to reconsider your risk tolerance and to make sure you’re taking a prudent amount of risk for your age and life situation. It is also a good time to consider your asset allocation and diversification strategies. Usually, the younger you are, the more you can consider taking a little more calculated risk by looking at growth-oriented stocks – like healthcare, tech, consumer discretionary sectors and international markets.
When meeting with your Hefren-Tillotson advisor, he or she will check your intended asset mix to possibly rebalance and ensure that it meets your time frame, needs and preferences, and your risk tolerance.
While stocks often appear to be inherently risky, as long as you’re diversifying your portfolio, your growth rate will average out to be positive over the years. Ask your Hefren-Tillotson advisor for more details about how this works.