Last week we learned about building a solid investment program based on an asset allocation and diversification strategy that is tailored to you and your financial goals.
You should keep in mind that this strategy should only change if your life has been significantly altered in some way, e.g., you have taken a new job, married recently or entered into retirement. Also if you find that you’ve become uncomfortable with the levels of risk that you are taking as a result of the asset allocation you initially set, you should consider revisiting this step to set a new, more appropriate allocation.
This is a one-time or occasional event, not a knee-jerk reaction to market levels!
Consider the following as you think about your retirement investments during the current economic environment
Remember that you are investing for the long-term. At times of market volatility, naturally many people have concerns about their savings and questions about what action, if any, they should be taking in light of all the media headlines and news. It can be unsettling to see swings in the value of your savings as markets appear to react daily to economic and political developments. One bad decision made in panic can take a big bite out of the long-term return you need to retire. Discipline in moments like these will save you. Emotions run high at times like these, but emotions are not a good basis for investment decision-making. It is natural to want to exercise control over events that are essentially uncontrollable. However, even professional investors have difficulty timing the markets, and few do it successfully over time.
Rebalancing. You need to focus on what you can control. Is your asset allocation appropriate? Will you have the discipline to rebalance, (i.e., lower your stock allocation in rising markets as your stock weighting rises above your target and then actually add to stocks in falling markets if allocations fall below targets)? Let’s look at a simple example in a period where the stock market is falling: a $1 million portfolio at the beginning of this year starts with an asset allocation of 60% stocks and 40% bonds. If no changes are been made all year and the market falls 20%, the stock portion of the portfolio would now be worth $480,000. Assuming bonds remained flat, the bond portion of the portfolio is still worth $400,000 and the total portfolio is now $880,000 with a 55% stock/45% bond allocation. What do you do? If your risk tolerance, long-term objectives and time horizon haven’t changed, then you have the opportunity to rebalance back to your targeted asset allocation of 60% stocks/40% bonds. Returning to the strategic allocation gives you the best chance to recover the losses by “selling high” some of the bond portfolio, and “buying low” at the bargain prices in the stock markets. You have ensured that you will have the opportunity to participate in any recovery of the stock market.
Rebalancing can be emotionally difficult; when things look particularly bad for the markets, the economy and the consumer, it is very difficult to buy into risky asset classes that just burned you. But a significant risk in investing is being out of the market and not being positioned to participate in the recoveries. Recoveries from bear markets tend to take place in spurts and tend to be concentrated in a few good days, which you don’t want to miss. So, when you attempt to fix things by trading, you are paying your broker, but not necessarily helping to accumulate long-term wealth. A good investment strategy provides the discipline to rebalance regularly, keeping emotions out of the decision-making process.
Continue to save. It may seem counter-intuitive to add to your retirement portfolio when times seem tough in the markets, but your retirement dollars actually buy more when the markets are low. A consistent savings program is essential in meeting your retirement objectives. Whatever you do, continue to save! Even when the markets dip down, be sure to continue your program of consistent investing.
Maintaining discipline through times of euphoria and through times of heightened concern and even panic is within our control. It is a critical component of long- term success. It is by no means easy given the barrage of information the media throws at you. Also, a number of advertisements directly target consumers suggesting they buy a hot or trending security. You want to avoid reacting emotionally to these messages. And you certainly want to avoid making investment decisions based solely on an advertisement. If you stay the course, you avoid these peaks and valleys. It takes discipline. But, a pattern of staying invested is likely to yield higher returns and more assets for you at retirement! You want to stay committed to your well thought-out investment strategy that we’ve covered in the previous blog posts.