Stock markets despise the fear of the uncertainty. This theme can be magnified by current events like the coronavirus, future events like the 2020 political elections, or a number of other issues.
Fear can often move stock markets lower, while optimism generally will lead to higher stock markets.
When a few large companies report solid earnings and higher earnings expectations stock markets often rise. When we hear daily reports of a potential global health risk, markets might endure a brief downturn.
Maintaining a properly-diversified portfolio is one the best defensive practices against making portfolio mistakes driven by fear.
No one enjoys fear, with perhaps a few exceptions such as fans of Halloween-esque events and movies or thrill seekers at an amusement park. Being fearful within the investing world should be avoided by diversification and asset allocation tailored to an individual’s needs.
Diversification means having a number of pieces inside a portfolio – different types of stocks and bonds is the general, yet overly simplistic idea.
Asset allocation is the percentage allocation to stock and the percentage allocation to bonds.
A diversified portfolio might fall into the categories of aggressive, balanced, conservative, or even somewhere in between.
An aggressive investor could imply that being nearly 100 percent stock so if the stock market rises 25 percent, the investor would expect a similar return. If markets fall 40 percent, well, that’s the risk – the portfolio probably would experience a similar drop.
Balanced investors might be more in the 50- to 60-percent stock to 40- to 50-percent bond. Personally, this is in-line with more of my investing beliefs and strategy as when markets rise, investors are usually pretty content. When markets become more volatile due to the fear of the unknown or other events, investors need to be protected a bit more. This is the hallmark of being diversified within your own asset allocation or risk level. A balanced approach can also be useful in at least a portion of a portfolio.
When markets bounce around, a balanced portfolio gives us a chance to buy a little more on the dip or take a little bit of gains on the portions that have moved higher.
Conservative investors may continue to struggle with ultra-low interest rates that fail to keep pace with low inflation. That will likely be a challenge for years to come because of the dynamics of Fed policy.
For these unforeseen events that are currently causing fear in markets and future events that will occur, having the appropriate strategy that mirrors risk tolerance should help one sleep better at night. This tactic applies to investors regardless of age.
For those in the throes of retirement, it is critical to focus on expense and income vs. trying to take too much risk in a portfolio. Knowing the cash flow in and out of the household budget and trying to live off of one’s anticipated retirement budget for a year or two prior to retirement, can help to reduce the worry of stock market gyrations.
This is general information designed to provide an overview of ideas and not meant to be specific advice. In fact, nearly all investors look at risk differently, as should be the case since individual goals vary.