Unfortunately, market swings are a normal part of investing. Though a volatile market can be unsettling, it shouldn’t stop you from focusing on working toward your financial goals. During uncertain times, many investors may panic and find themselves tempted to pull out of the market altogether.
However, this option is not going to get you any closer to reaching your long-term financial goals. Similarly, other investors may react to changes in the market by doing nothing, which may also not be the best way to progress toward long-term investment goals. Though changes in the market can be alarming, there is some comfort in change when you understand what you own and why.
As Warren Buffet said about being prepared – “Predicting rain doesn’t count. Building arks does.”1 If you want to plan for storms in the stock market, consider what these fluctuations might mean for your individual investment portfolio and adjust your risk accordingly. Below are a few steps you need to take when adjusting your investment risk in a volatile market:
Determine the goal of your funds.
How you will adjust your investment risk in a volatile market depends greatly on what your goals are for investing in the first place. Your reasons for investing not only impact how much you want to earn over time but also what your risk tolerance is, both of which have an effect on your approach to investing in a volatile market.
If your goal is to create a financial safety net for you and your family or if you have a shorter timeline to invest, then you may not have as high of a risk tolerance as other investors who need to be more aggressive to meet their investing goals. On the other hand, if your goal is to maximize wealth or generate retirement income and you have a longer timeline, you may be able to tolerate more risk in a volatile market.
Take a financial inventory.
Once you have a clearer idea of what your investment goals are, it’s time to take an inventory of your financials. Essentially, a financial inventory is a list of your assets and debts. This inventory will give you a better understanding of where you are starting from, which helps you determine what level of risk you will need to take on to meet your long-term financial goals.
Here are just a few of the different accounts you will need to consider when completing a financial inventory:
- Retirement Accounts – Document any retirement accounts, including any 401(k) or 403(b) plans offered by your employer as well as IRAs, Roth IRAs, and health savings accounts.
- Brokerage Account – Include your brokerage accounts, whether they are self-directed or overseen by a financial advisor.
- Cash reserves – Include any cash that you have in a checking or savings account as part of your overall assets.
- Insurance – Consider any life insurance policies that contain cash value.
- Orphaned Assets – If you have retirement accounts in an old company plan they are considered orphaned, include these in your inventory.
- Future Inheritances or Windfalls – Include any known inheritances or potential windfalls as a footnote in your financial inventory.
By taking an inventory of your current assets, you’ll have a better idea of how aggressive you will need to be when investing in order to meet your long-term financial goals.
Understand what level of loss you are comfortable with.
When you don’t properly define your risk, you may start to feel significant discomfort that can occupy much of your valuable mental shelf space. If you want to best understand what level of loss you are comfortable with, you’ll need to educate yourself on what your risk capacity and tolerance are. Risk capacity is the measure of how much risk you can handle before it may start to impact your long-term financial goals. Your risk tolerance is your ability to handle volatility and potential loss on your investments from a personal perspective.
One of the most effective ways to understand the level of risk you are comfortable with is by building a risk profile. Once you know what your risk capacity and tolerance are, you can adjust your approach to investing in volatile markets.
Want to effectively adjust your approach to investing risk for market volatility? Call CM&A now for a 30-minute consultation with one of our financial advisors: (262) 790-9966.
Sources:
- As quoted in BNN Bloomberg, 2018.