If you’re traveling down an open road, you may feel quite comfortable driving 10 miles per hour over the speed limit.
The ride is smooth and uneventful. You can look in your rearview mirror and see the road you’ve just traveled, and you can look straight ahead and feel confident that you are safe continuing at that speed. But then you see something in the distance—it looks like you are approaching some twists and turns, and you see the brake lights of other cars. What do you do? Do you continue on your course, full speed ahead, believing that you’ll get to your destination more quickly? Or do you hit your breaks, feeling uncomfortable with the uncertainty that lies ahead?
During these uncertain economic times, it is more important than ever to understand how you feel about risk.
“Market risk” is the risk of losses in your investments arising from movements in market prices. It often seems that people are very comfortable with risk, as long as they are making money. Some investors have a tendency to justify their comfort level with risk by looking in their rearview mirror at stellar returns from prior years. But, when the pendulum swings in the other direction and investors experience extreme volatility, they may discover that they aren’t as comfortable with risk as they once thought.
For the portion of your portfolio that is exposed to market risk, there are two basic approaches to dealing with the winding road.
1. I’m not changing my speed; I’ll take the risk through these twists and turns.
You may get into more crashes than the more cautious cars, but, over the long term, you very well may be one of the first to reach your destination. In theory, this approach makes sense—you are in it for the long haul, so who cares about a crash or two? Sticking with an aggressive and passive investment strategy is a viable approach, but be prepared to stomach the worst parts of the markets.
2. I’m changing my speed as the road changes; I don’t want to risk having a fatal accident.
If you slow down, you reduce your risk of being involved in a terrible crash. This approach is not about timing the market; it is about recognizing uncertain conditions and proceeding with caution. Reducing risk can provide peace of mind because you are less exposed to a crash. Managing volatility is also a viable approach, but be aware that reducing risk and volatility may mean reducing potential returns.
As an investor, you really need to ask yourself how you would feel about losing 20 percent, 30 percent, even 40 percent of your investment portfolio. Really, really think about it. Imagine your 401(k) statement, succinctly conveying your hard work of scrimping and saving with just one number: $100,000. Now, as you look at your new statement, it reads just $60,000. If you don’t think you’d react well to this volatility, or if you are nearing retirement and can no longer afford huge investment losses, you may want to consider exploring your options for reducing risk within your portfolio.
It is important to talk to your financial advisor about your risk tolerance, but it is much more important for you to look within yourself and understand how you feel about risk. Don’t wait until you’ve experienced volatility to decide if you can bear it.
Alison Bach is a certified financial planner for Conte Wealth Advisors in Camp Hill. Visit their website, www.contewealthadvisors.com.
Registered Representative Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Cambridge and Conte Wealth Advisors are not affiliated. 2009 Market Street, Camp Hill, PA 17011.
