In today's tumultuous markets, investors have experienced significant volatility and potential reduction in the value of their retirement accounts and portfolios. Choosing to save and delay benefit today for value in the future can be challenging, which leads to increased emotion about money and investments. The challenge investors are presented with is that snap decisions based purely on emotion often lead to investments that have negative effects on the long-term performance and reduced growth potential. Rather than taking a short-term, emotional approach, investors should work to develop a long-term strategy with proper diversification.
When markets become volatile, many investors' first instinct is to sell everything and move out of the market, accepting their losses; other investors flee to perceived safety in conservative investments which can reduce long-term growth potential. Neither of these outcomes are optimal and, fortunately, there are better ways to handle challenging times despite a tough market.
A critical starting point is to develop an understanding of your goals, both for the short and longer terms. Once you have determined what you are trying to achieve, there are four key steps to working to safeguard your financial picture through positive and negative market cycles.
Step One: Develop a Plan- To reach any goal, whether in your career or financial life, you need to understand what you are trying to achieve. As an example, if you are focused on reaching retirement, it is important to have an understanding of when you want to retire, the level of living expenses you want in retirement, the assets you have built thus far, and how you can build additional savings for the future. As you develop answers to these questions, you and your financial professional can work together to build an investment portfolio and strategy to help you toward reaching your goals. Equally important is building a plan that takes into account the varied elements of your financial picture, including savings and estate planning strategies, as well as various types of insurance protection for you and your family.
Step Two: Prepare for Rainy Days- Life can bring uncertainties; building a house with a weak foundation results in unexpected problems. Therefore, build a good foundation including an emergency reserve that can help get you through difficult times. Put in place efficient life insurance and long-term care insurance, and make sure you have a will, including the living documents. Once you have built the foundation of your financial future, you can embark on building long-term investments.
Step Three: Be Diversified- Regardless of your risk tolerance as an investor, you are exposed to additional risk if you are over-concentrated in any one area. Historically, investors who have successfully weathered market fluctuations and cycles have had a variety of investments. These range from various types of bonds and income generating investments to a stock portfolio with diversification across geographies and both value and growth focused companies in various sectors.
A critical step in diversification is asset allocation. This is the strategy of determining what bond and equity allocations you have in your portfolio. This is valuable for several reasons. The first key is that by investing in equities in various geographies and sectors, combined with diversified bond holdings, you may be able to better tolerate downward movements in the market. Additionally, it is essentially impossible to predict who will be the winners over the next few years. By owning a diversified group of investments, you can build a more balanced portfolio that may not be so susceptible to drastic market movements.
Each investor will have a different asset allocation based on their desire or willingness to take risk, investment experience, goals, tax bracket, age, etc. Of course, it is always important to understand that diversification and asset allocation do not guarantee a profit or protection against loss in a declining market. All investments are subject to market and other risks, will fluctuate in value, and may lose principal value invested.
Step Four: Revisit Your Plans- As life events happen and goals change, so too will the strategies and asset mixes that are appropriate for you. Many events in life can drastically change your financial picture, such as the birth of a child or grandchild, salary increases, inheritances, etc. As events in life change your focus, you should revisit your goals and make sure your strategies are still leading you to the desired destination.
Rebalancing is also a key part of managing your portfolio. As markets fluctuate, the allocation between sectors and equities vs. bonds will naturally change. A positive year for international equities, for example, could result in your portfolio being overly focused on that area and thus out of alignment. By rebalancing, you can sell some of the sector that recently did well and buy more of the sectors that have not yet performed. This fits in line with the classic investment guidance of "Buy Low and Sell High." Additionally, while rebalancing cannot guarantee a profit or protection against loss in a declining market, it can help you monitor the actual risks you are taking and help you avoid taking substantially more risk than you intended.
Working with a financial planner and developing a strategy can help you to manage your finances in a volatile and changing market. Preparing for your future and managing risk means more than an occasional meeting with a financial professional. It is about making your money work for you and accomplishing your financial goals, whether they are reaching retirement, sending children to college, leaving a financial legacy or taking a dream vacation. By developing a solid plan based on your goals, you can be prepared for life's opportunities and challenges.
