Why Assessing Your Investment Risk Tolerance Can Reduce Your Stress During Bear Markets
As we’ve seen over the last month, things can change very quickly. Unexpected change can invoke a lot of panic, which is what happened during the stock market downturn this march. Because of this change many people were unprepared for what was to come, so now is a good time to reflect and reassess to get back on track. We’re going to go over some of the characteristics of a bear market, and how assessing your investment risk tolerance can reduce stress if and when a bear market occurs.
Bear Market Characteristics
A bear market is defined as an episode where US large-cap stocks fall by at least 20% from peak to trough. While these stocks are used as the basis for defining bear markets, a portfolio of stocks and bonds sometimes reduces volatility and lessens the market losses.
When assessing risk for bear markets, it’s important to remember they occur about once every five years, vary in severity and how long they last. Since the turn of the century, we have seen three very sharp corrections. Think of the markets as your car ride to retirement or other goals you set. the more stock you put in your portfolio correlates with how fast you drive and how soon you may get there. However, with speed comes more discomfort (volatility) and greater risk of an accident (crash you don't recover from quickly). How much comfort and safety are you willing to sacrifice to get there earlier? Will you get there on-time without excessive speed?
Assessing Your Risk for Bear Markets
Think Structurally. Make sure your portfolio is taking the right amount of risk in order to meet your short-term and long-term objectives. Having structure will better protect you for when the market changes.
Plan Strategically. The best way to manage equity risk is by trimming some stocks from your portfolio in favor of higher allocation to things such as municipal bonds. Keep in mind that large changes in your portfolio’s allocation should rarely be made. Emotions run higher than reason when markets become volatile, so jumping in or out of the market based on short-term forecasts is going to put you at risk.
Preparing Your Portfolio
While having your asset allocation aligned with your risk tolerance and investment goals can prepare you for when the market is volatile, you’ll never be able to prevent downturns. To reduce stress for when it happens, consider doing the following:
Know Your Goals
You started investing for a reason, whether that be preparing for retirement, college, or buying a home. These goals helped you determine your investment risk, so remember why they matter and whether they’re short-term or long-term.
Diversify Your Investments
You know the saying “don’t put all your eggs in one basket” well the same goes for your investments. One way to reduce risk in your portfolio is to invest across sectors such as tech, healthcare, industrial and more.