What a difference a few weeks makes: the DOW Jones Industrial Average and the S&P 500 both fell about 10% from the beginning of the year to mid-February. Then, the DOW rallied 1,013 points or 6.53% from the low on February 11. This all happened in the space of 11 days. As of the close on February 29, both indexes are still down in the range of 5%. It's certainly been a wild ride. (1)
As I said last month in my article The Stock Market: Time to Panic! or Time to Buy!???, while these kinds of markets can keep you on the edge of your seat, over the long run we usually forget about them.
That doesn't mean they're easy to get through. For a lot of investors, it doesn't matter if this will end up as just another blip on the radar because they're losing sleep over it right now.
If you're in the same boat -- or if you've been avoiding all of the turmoil because you're worried about your account balance -- now that the market has done an about-face from the bottom, it might be a good opportunity to step back and rethink your asset allocation.
Balancing performance with blood pressure
Changing an allocation that's not in line with your real risk profile might be a good idea. Don't get me wrong: I'll be the first one to tell you that, in the long run (when time is on your side), equities tend to drive portfolio returns. I've been doing this for 24 years, and I believe that investing in the stock market is at the very top of the list of things you can do to grow your savings over time -- but only if you're prepared for the risk.
The key to making it work is prudent diversification.
A well-diversified portfolio may not grow as dramatically as betting on an individual stock or two when times are good, but it should offer you much less volatility when markets go through swings like the ones we've recently seen. I like to help my clients construct portfolios that incorporate many asset classes and include specialized managers. Overall, my goal is to help harness growth opportunities in the market without exposing my clients' portfolios to too much risk in any one area.
However, sometimes a specific asset allocation plan can make sense on paper but not in practice. If a potential client comes to me feeling anxious because of the market and they don't know what to do, I take it as a sign that they need to reevaluate their strategy.
Reevaluating poor performance
At the end of the day, you have to balance the financial with the emotional, and sometimes that means reducing risk simply because it helps you sleep at night. While there are investors who build higher-risk portfolios on purpose, most people should consider a slow and steady approach.
That's why I put so much emphasis on portfolio construction. An appropriately diversified portfolio should help cushion falls in the market -- which will also take some of the stress out of volatility.
Of course, if you're not sure of what your performance is, it's time to take a look.
A lot of investors hide their heads in the sand when the market gets rough. This makes complete sense psychologically, but it could be a very bad idea financially. If you're avoiding your account statements or if you've lost track of where all your accounts are, this could be the right time to get back into the game. Volatile markets bring a wealth of opportunity, so instead of ignoring the news now is a good time to use it.
How do you know if you need to do something?
You might know in your gut that it's time to take action on your accounts and your allocation strategy. But if you're not sure, consider these questions:
• Do you feel that your portfolio is well-diversified?
• Do you understand the logic behind your asset allocation -- and do you know what that allocation is?
• Do you know how your long-term portfolio has performed relative to the market?
• Have you reviewed or rebalanced your accounts in the last 2 years?
• Have you avoided rolling over an old 401(k) because it seems like too much work?
• Have you stopped opening your account statements?
If you're unsure about your allocation or performance, or if you've been avoiding dealing with your investments altogether, now could be a good time to think about your asset allocation. You could start by by consolidating your accounts -- roll over old 401(k)s, put different brokerage accounts together, and so on. This helps many investors get a clearer picture of where their money is.
Next, it's time to address your asset allocation. Do you feel comfortable with the level of risk in your account?
If you're not sure about the answers or don't know how to address them, you might want to consider talking to an advisor. A good advisor will not only help you design an allocation strategy but will take the time to answer all of your questions. This is much more important than most people realize: if you know why your account is allocated in a certain way, the market ups and downs should be a lot less stressful. An understanding of the big picture can really help you cut through short term volatility.
Of course, sometimes allocations don't work for an individual no matter how logical they are. Like I said before, it's a matter of balancing the financial with the emotional, and markets like these are a good testing ground for thinking about that balance. If you're totally on top of your accounts and understand the strategy but you're still struggling, it's a good time to rethink your plans. There's no shame in building a portfolio that doesn't keep you up at night -- especially if it helps you avoid making emotional decisions when the going gets tough.
We have no idea what the next weeks and months will bring, but 2016 has been a wild ride already. To get through it, make sure you're comfortable with your investment strategy. The rest is the discipline to keep an eye on the long term.
If you need help thinking through any of these questions or if you'd like more detail on how to plan an investment strategy, don't hesitate to get in touch. I'm here to help!