A certain amount of volatility is to be expected when investing in the stock market. But the past couple of months have taken investors on a wild roller-coaster ride that has even some experienced traders feeling a little bit dizzy.
Volatility Becoming the Norm
A trend line showing the daily closings of major stock market indices this year looks like an EKG on steroids. For example, the markets fell steeply in February and March, only to bounce back strong and set new records in early October. Then the bottom seemed to fall out again as the Dow Jones Industrial Average plunged nearly 1,600 points in just one week.
After a brief bounce back, the Dow plummeted by more than 1,900 points during a two-week period in November. Daily swings in the Dow of 400 to 500 points or more have almost become commonplace.
This kind of volatility has some people taking a fresh look at their investment risk tolerance. It’s one thing to tell your investment advisor that you’re comfortable with high levels of market volatility, but it’s another thing to actually experience wild swings like those we’ve been seeing lately.
Time to Reassess?
If the recent market volatility has you lying awake at night worrying about your investment portfolio or retirement account, it might be a good idea to reassess your level of risk tolerance. It could be that you have more money invested in higher-risk securities like stocks than you’re really comfortable with.
Everyone’s risk tolerance is different, and there’s no right or wrong level for any one person. Only you know how much investment risk you’re really comfortable taking — and the past couple of months have provided a good test to gauge whether your asset allocation accurately reflects your risk tolerance.
Let’s say that due to the recent market volatility, you’ve been very worried about losing money in your retirement account and not being able to retire when you want to. Let’s also say that your retirement portfolio is currently weighted 80 percent stocks, 10 percent fixed-income and 10 percent cash equivalents. In this scenario, you may have a lower risk tolerance than you originally thought and you might want to consider allocating a higher percentage of your assets to fixed-income instruments and cash equivalents.
Now let’s assume that you’ve taken the recent market volatility in stride and haven’t really worried about it too much or lost any sleep over it. Let’s also assume that your retirement portfolio is currently weighted 50 percent stocks, 25 percent fixed-income and 25 percent cash equivalents. In this scenario, you may have a higher risk tolerance than you originally thought and you might want to consider allocating a higher percentage of your assets to stocks.
What’s Your Time Horizon?
Regardless of where you end up on the risk tolerance spectrum, it’s important to consider your time horizon when deciding how to allocate your investment assets. In general, the longer your investing timeframe, the more risk you can assume with your investments. This is because you’ll have more time to recover any losses that occur due to short-term market volatility.
When investing for retirement, the question then becomes how many years are there until you plan to retire? If you’re relatively young — like in your 20s or 30s — you may have an investing timeframe of 30 to 40 years or longer. This should afford you the ability to assume a little more risk with your investments since you have so much time to recover short-term losses.
However, if you’re in your 50s or 60s, you probably have a much shorter investing timeframe of perhaps 10 to 15 years or less. Since you may not have a lot of time to recover losses incurred during volatile markets, you might want to keep more of your assets in lower-risk investments like fixed-income securities and cash equivalents.
Keeping Things In Sync
The most important factors when it comes to dealing with market volatility are knowing your risk tolerance and making sure your investment portfolio reflects this. If these two factors, along with your investing time frame, aren’t in sync, you might end up experiencing some sleepless nights when the markets turn volatile.
Please contact us if you have any questions about dealing with market volatility.