I currently have approximately $225,000 invested in the stock market. Most of that is in conservative stocks and bonds. Do you have an opinion about staying the course or liquidating all or a portion for a few months or years during this newest crisis?
Your question is a reasonable one and addresses a common theme among investors. Naturally, a volatile market and unpleasant economic conditions will cause some concern. They may have people questioning whether they should be doing something different with their investments – such as selling them all and holding cash – to avoid potential losses.
However, making investment decisions based on what you expect markets to do is usually not the best approach. I always recommend staying the course, assuming you are on a clearly defined course.
While I can’t directly advise you on what you should do in this setting, I can educate you to help you make a decision.
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Pitfalls of Trying to Time the Market
The biggest issue with jumping out of the market when things appear like they will be rough for a while is timing.
How do you know when it is the right time to sell? The simple reality is that you can’t know with any degree of certainty.
I’ll suppress my inner academic desire to explain this from a theoretical perspective. Instead, we can take recent history as a concrete example.
On Feb. 14, 2020, the S&P 500 was at 3,380. But by March 23, the S&P 500, which is the most widely used broad measure of the U.S. stock market, had fallen to 2,237.
The middle of February was the time to sell to avoid that approximately 30% decline. But who knew that on Feb. 14 when the information was useful?
The answer is nobody. A global health pandemic and widespread economic disruption were barreling toward American investors, but most of them didn’t know it yet.
Sure, you can estimate, model, suspect, postulate, guess or, if you’re really desperate, read tea leaves. But ultimately, you cannot precisely predict these types of things.
Downsides of Attempting to Time Market Reentry
The next step is knowing when to get back in so that you can participate in the upside when the market turns a corner. If you had sold in February 2020, would you have known that by the end of March you needed to buy back in? From that point, the S&P 500 had a relatively steady climb to close out 2021 at 4,766.
Better yet, from a psychological or emotional standpoint, would you have been willing to after watching the market tank by over 30% in such a short period? The answer is probably not. You would have likely missed at least some of that rebound.
And of course, that cycle just continues. The S&P 500 closed just shy of 4,800 on Jan. 1, 2022. Sell or not? Even within a single day, the markets can rise and fall precipitously. What a rollercoaster.
Choosing a Portfolio
Since investors can’t know for sure what the markets may do over a given period of time, they need a better way to make investment decisions that don’t rely on market timing.
My recommended approach, which is common among financial planners, is to make sure that investment decisions incorporate the investor’s risk tolerance and are aligned with client goals, including the appropriate time horizon.
Big picture: This means choosing an asset allocation and holding a broadly diversified portfolio.
Choosing Asset Allocation
Your asset allocation is the balance between different asset classes such as stocks and bonds.
For example, you may hold 70% stocks and 30% bonds. Or you may hold 50% stocks and 50% bonds. You might select any other mix.
These asset allocations break down further into different types of holdings within classes, such as short-term and long-term bonds, and U.S. stock versus foreign stock. For our purposes, however, we can keep this example at a high level.
Your asset allocation determines how aggressive your portfolio is. The more stock you have, the more aggressive the portfolio remains. So, a portfolio of 80% stocks and 20% bonds will be more aggressive than a portfolio of 60% stocks and 40% bonds.
The more aggressive your portfolio is, the more you can expect it to fluctuate. In climbing markets, an aggressive portfolio usually grows more than a conservative one. An aggressive portfolio drops more in a falling market.
Considering Financial Goals
You’ll also consider your financial goals in your portfolio choice.
Some questions you may ask yourself include:
Do I have a long time or will I need the money soon?
How much money will I need?
Are my goals flexible such that I might be able to delay or reduce expenses or does the money have to be there when I need it?
These are the types of questions that come into play.
Staying the Course
It’s important to align your asset allocation choice with your tolerance for risk.
That’s because once you set it, you don’t change it based on market expectations.
In other words, if you determine that you are a conservative investor, you choose a conservative asset allocation. You shouldn’t move to an aggressive allocation when you think there’s a chance the market is about to take off.
Conversely, which is what we are talking about here with your question, you don’t move to a more conservative asset allocation when you think the future may not look so rosy.
That doesn’t mean you don’t ever look at your investments again. You’ll need to rebalance as the market drifts and moves your portfolio out of your intended allocation.
It’s also good to reevaluate your risk tolerance because that may change with experience and education. It’s wise to update your portfolio in these situations, just don’t trick yourself into crossing the line into market timing.
What to Do Next
Understanding your risk tolerance usually involves responding to a series of hypothetical scenarios from a risk-tolerance questionnaire. For example, you may respond to the question “What would you do if markets dropped by 30%?” with answers such as “Buy the dip” or “Sell to avoid further losses.”
There are usually more complex questions, too. Your answers are then scored on a scale to give you an estimate of your appetite for risk.
Bottom line: Evaluate your risk tolerance, define your goals if you haven’t already, choose an asset allocation based on your risk and goals, and then stay the course.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAdvisor Match platform.
Investing and Retirement Planning Tips
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