When the stock market is on the rise, investors can fall into the trap of believing the good times will never end. But in all probability, market volatility will return, and chances are it’ll be when it’s least expected.
Rather than waiting for it to happen and risking the possibility of panicking and making costly investment decisions, you may want to think about volatility during those good times. That way, you can be strategic rather than emotional about dealing with it, which may lead to better outcomes.
What type of investor are you?
1. You have an investment plan.
1. You don’t have an investment plan.
Let’s begin by addressing type 2 investors.
Quite simply, if you don’t have an investment plan, you should think about creating one, and here’s why: A well-thought-out plan is built around what you’re investing for (goals), how long you have until you need to tap into your investments (time horizon), and, most important for this topic, the amount of market volatility you’re comfortable with (risk tolerance).
Taking these factors into consideration, your plan should include a strategic asset allocation, which is how your portfolio is divvied up between different types of investments — primarily stocks, bonds and cash alternatives.
You may be the type of investor who takes market volatility in stride. In that case, you likely have a relatively high-risk tolerance. On the other hand, volatility may make it hard for you to sleep and cause you to panic, which would mean your risk tolerance is probably rather low.
If you’re the second type of investor, a larger portion of your asset allocation would likely be in bonds, which historically have been more stable than stocks. However, along with that relative stability generally comes significantly lower returns.
What if you already have a plan?
If you have an investment plan, you should be thinking about whether your portfolio is currently aligned with your strategic asset allocation.
While it might be nice if you could set and forget your asset allocation, the fact is overtime market activity can cause your investments to drift away — sometimes far away — from where you want them to be if you don’t keep an eye on them.
For example, a hypothetical 50% stocks, 45% bonds and 5% cash alternatives portfolio could become a 60% stocks, 35% bonds and 5% cash alternatives portfolio without you realizing it. While that “new” portfolio may provide better returns, it’s also likely to fluctuate more in value if the market becomes volatile. In other words, you could be exceeding your risk tolerance without being aware of it.
To help avoid this situation, consider periodically rebalancing your portfolio when necessary, which may require selling some investments and purchasing others to bring it back to your intended asset allocation.
Because creating a plan and keeping it in balance can be complicated, for help you may want to turn to a financial adviser with the necessary tools and experience.
Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.
This article was written by/for Wells Fargo Advisors and provided courtesy of Ponte Vedra Wealth Management Group in Ponte Vedra Beach at 904-273-7918.
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