All investments experience market volatility, which is why retirement portfolio strategies should focus on allocating assets across investments of different risk levels.
Riding toward that retirement red zone can be a little too thrilling when the markets are falling. But it’s necessary to find equilibrium on the confidence/ambiguity spectrum in the best and worst of times.
As you move toward your retirement goals, it can be important to maintain a long-term focus, especially when it comes to market volatility. To watch markets fluctuate, particularly during more stressful moments, can be a gut-wrenching experience and can lead to selling at market bottoms. Those who sold at the height of the financial crisis or stayed on the sidelines as the markets recovered may have missed out on a generational opportunity to accumulate assets.
No matter what the situation, you can find instruments that have upside, or downside, profit potential. The challenge is that they all involve some level of risk and volatility, which can make them seem scary. So how are volatility and risk related in an investment?
Bear markets, defined as a 20% drop in market valuation, come and go with market cycles. Market corrections, which are closer to a 10% retreat, happen with relative frequency.
A 2018 research piece by Guggenheim Investments revealed that, on average, the market has had a pullback of at least 5% about 1.65 times per year since 1946. Smaller downturns have tended to recover quickly. A pullback between 5% and 10% has historically recovered in a month on average; a correction of between 10% and 20% has taken four months to recover. Even a bear market of between 20% and 40% has recovered, on average, within 15 months.
The S&P 500 (SPX) has sunk into bear market territory 12 times in the last 75 years, but it’s also risen from its original low double digits to a high above 3,000 in 2019. In other words, perhaps Lesson No. 1 on the confidence/ambiguity meter is not to let market gyrations upend your long-term investment strategy.
That doesn’t mean, of course, that every stock investment will pay off. You have to do your investment homework to learn about various types of investments, stock and economic fundamentals, and outlooks on individual companies and investment funds.
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Another notch on the “certainty” post is to keep the asset allocation of your portfolio properly balanced relative to your risk tolerance. Again, stocks have historically done well over time, but you don’t want to bet the house on them. Consider what type of stock mix might make the most sense for your situation. Cash and bonds, with their lower but sometimes more predictable longer-run returns, may be the yang to the yin of turbulence in the stock market.
Foolproof? Nope. Even cash isn’t always a lifesaver, as its value tends to erode over time because of inflation. Plus, there’s always the risk that a portfolio dedicated to cash for too long might miss valuable opportunities in the stock market.
Keep in mind that although diversification doesn’t guarantee against investment loss, diversification among stocks lets you spread your investment across different assets and markets, helping to limit wild swings both up and down. Exposure to defensive sectors, such as Health Care and Consumer Staples, may provide some protection to your investments on the downside when the higher-growth, higher-volatility sectors such as Technology or Housing fizzle.
During times of market volatility, even diversified portfolios can lose money, although a diversified portfolio’s drawdowns may be less pronounced than those of the overall equity markets. The bottom line: Rather than focusing on individual holdings in your portfolio that are doing poorly, it can be important to take a step back and ask yourself how the entire portfolio is doing.
Your goals may change over time for different reasons. If you’re just starting out and happen to run into a period of volatility up front, you may need to give yourself a little more time for diversification and the potential benefits of long-term accumulation to kick in. After all, some of the best market days come immediately after the worst.
If you’re nearing retirement, it might be a good idea to do a quick check on whether your assets are allocated to the types of risks you’re comfortable with. The goal of diversifying your assets across different asset classes is to help provide a smoother journey toward specific objectives in light of market volatility, which does tend to appear from time to time. When starting out, investors tend to have more capacity to withstand volatile markets given their longer time horizon. But over time, investors may want to consider tweaking their retirement portfolio strategies by rotating their portfolios into lower-volatility asset classes like fixed income to help temper the effect of volatility on their overall portfolios.
Investing is a game of patience, prudence, and resilience. Not clairvoyance.
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