Does your stomach sink when you watch the news and see that the financial markets have corrected and lost value, or do you view a market correction as an opportunity to invest more dollars and get into the market at a more reasonable cost? How you answer this question likely reveals a lot about your risk tolerance, and your risk tolerance likely depends on where you are in your financial journey. Those investors who are at or near retirement age may not be able to tolerate large market swings that could significantly reduce their portfolio values. This, in part, is due to the fact that if their account values swing too wildly, they may not have enough time in the market for their account values to recover before needing to withdraw additional funds for living expenses. Younger investors, on the other hand, generally have the ability to withstand more market volatility because they have a longer time horizon to invest. In many cases, younger investors will be entrenched in the workforce for 10, 20, or even 30 years, before they have to begin accessing their investments for retirement expenses. As a result, younger investors are not only better positioned to weather a correction, but they can also have the potential to benefit greatly over the long-run by investing additional funds into the market during a correction.
In order to better align your investments with your risk tolerance, there are two risk management strategies that your financial advisor should be implementing on your behalf: asset allocation and diversification.
How is Your Account Invested: Asset Allocation. Once you have identified your risk tolerance, you should review your investments to make sure that the assets are allocated in-line with your risk tolerance levels. In a nutshell, asset allocation is a way to help balance the risk and reward in your investment account by strategically investing a portion of your money in equities, fixed income, and cash. In general, equities (i.e. stocks, etc.) provide great long-term growth potential, but they are also volatile and can heighten risk in the short term. Fixed income (i.e. bonds, treasuries, etc.) tend to be less volatile, but they generally give weaker long-term returns than an equity. Cash, or cash equivalents, hold the least amount of risk in a portfolio, but they also generate the lowest returns. For those investors at or near retirement age, it is often recommended to reduce equity exposures and increase fixed income or cash exposures in order to reduce the overall risk within their account. With a more conservative equity exposure, a market correction may still have some impact on their account value, but not to the same extent as if the majority of their account were invested in equities.
What are You Invested in: Diversification. Once your investments are properly allocated, it’s equally important to make sure your holdings are diversified. The simplest way to explain diversification is this: don’t put all of your eggs into one basket. In the world of equities, you can invest in U.S. Large Cap stocks (companies over $10 billion); U.S. Mid Cap stocks (companies between $2 and $10 billion); U.S. Small Cap stocks (companies between $330 million and $2 billion); International stocks; Emerging Markets; and Real Estate, to name a few. The fixed income world is similar, in that you can choose to purchase corporate bonds, government bonds, municipal bonds, etc. Rather than simply investing in one equity fund and one fixed income holding, you can better manage your risk by diversifying your investments and owning across a variety of industries and other categories. Diversification will not guarantee against loss, but it aims to reduce risk by investing in different areas that would each react differently to the same event.
Investing in the market does come with inherent risk; however, by meeting regularly with your financial advisor and making sure that your portfolio is invested in-line with your risk tolerance and is diversified, accordingly, you can better understand and manage the risks that you’re taking. You may want to consider scheduling a review meeting with your advisor to make sure that your accounts are better positioned to weather any market adjustments, based on your needs.
Debra A. DeLeers is a financial advisor with Northright Financial, LLC and can be reached by email ddeleers@northrightfinancial.com or phone 920.712.7800.
Asset allocation and diversification do not ensure a profit or protect against loss in a declining market. Past performance is not a guarantee of future results.
Securities offered through Geneos Wealth Management, Inc. Member FINRA/SIPC. Advisory Services offered through N.E.W. Advisory Services, LLC. These are the views of Debra DeLeers and not necessarily Geneos Wealth Management, Inc. or N.E.W. Advisory Services, LLC. Geneos Wealth Management and N.E.W. Advisory Services do not provide tax or legal advice.