Why Now Is a Good Time to Revisit Your Risk Tolerance

Investing can be a bit of an emotional rollercoaster. Take the lump of coal investors got for Christmas in 2018. The Dow Jones Industrial Average fell 653 points, or 2.9 percent, that day, marking its worst session on the day before Christmas in its 122-year history. It was a fitting end to what turned out to be the worst year for stocks in a decade. To put it in perspective, cash – yes, cash – finished the year with better returns than any other asset class in 2018.

Think back to Christmas Eve 2018. Were you shopping for last-minute gifts while keeping an eye on your investments? Were you worried that money you will soon need won’t be there? Many investors don’t realize how risk averse they are until the sting of a market downturn arrives. That’s when the temptation to take corrective action is strongest, but it’s also a most inopportune time to make those changes. A recovery, on the other hand, is just the right time to make adjustments.

The end of 2018 is a prime example. Anyone who decided to sell around Christmas missed out on the rally that followed and has locked in losses by selling when the market fell. On the other hand, those who stayed invested likely saw the value they lost return. The S&P 500 rallied more than 18 percent in 2019 from its Christmas Eve low.

As we stand atop a rather nice recovery, now is a good time to ask yourself one question:

HOW DID YOU REALLY FEEL DURING THE CORRECTION?

Watching the value of your portfolio fall is never easy. But if you still have decades until retirement, 2018’s dip shouldn’t even register on your radar. Stocks are meant for achieving long-term financial goals, which means you should plan to hold onto investments for 10 years or more. Ups and downs will inevitably come – but you've got time on your side. Even after the worst recession of our lifetime in 2008, stocks have recovered and gained significant ground.

If you’re still on track to reach your goals, then you should remain equally as steadfast in your strategy when the next downturn rolls around.

“You are going to need to ride through equity market downturns — many of them. Stock returns are higher longer term because they are volatile, but not everyone can stomach owning them through downturns. Those who panic and sell pass their future gains on to those who don’t,” says Northwestern Mutual Chief Investment Strategist Brent Schutte.

Extreme market volatility is often the growing pain experienced just before higher returns, according to Schutte’s research looking at the VIX Volatility Index and subsequent stock performance. The VIX (a measure of expected price fluctuations in S&P 500 options) is sort of like the Ricther scale of market panic. When volatility is high, the VIX rises. Investors who sell stocks and move to the sidelines during periods of panic pay a high opportunity cost of foregone future strong stock market returns. Extreme pessimism tends to precede extremely positive stock market outcomes.

However, if you felt your goals were in serious jeopardy because you will need your money in fewer than 10 years or if 2018’s decline caused you more discomfort than you're willing to tolerate again, now is the time to proactively revisit your strategy. If you are likely to be tempted to push the sell button reactively when the market falls again, the recent strong recovery provides a timely opportunity to adjust your portfolio’s risk level.

Your risk exposure is primarily driven by asset allocation, or the mix of stocks, bonds and cash equivalents in your accounts. A portfolio with 90 percent stocks and 10 percent bonds, for example, is considered far riskier than a portfolio with 10 percent stocks and 90 percent bonds.

“If you didn’t like Q4, it’s going to happen again at some point. Figure out your risk tolerance and make adjustments now rather than waiting until the next downturn to shift your allocation,” says Schutte.

MAKING THE MOST OF A RECOVERY

The markets rise and fall. That means there are plenty of second chances for those who remain patient. If the bout of volatility in 2018 had you feeling too uneasy, a financial professional can help you determine an appropriate level of risk for your age and investment goals.

Remember, it’s always easier to patch the sails when the wind is calm than during stormy weather.

All investments pose some level of risk. Discuss your individual situation with a financial professional.