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Coronavirus, Bear Markets & Economic Recessions, Oh My! 5 Steps to Determining Your True Risk Tolerance Thumbnail

Coronavirus, Bear Markets & Economic Recessions, Oh My! 5 Steps to Determining Your True Risk Tolerance

This week we have experienced the most volatile market since the financial crisis and people have forgotten what a stock market plunge actually feels like. Up until now, we've been enjoying the experience of one of the longest economic expansions. Today, stocks plunged 10% in the Dow's worst day since 1987. Companies exposed to the coronavirus were most hard hit....airlines, cruises, etc. However, even companies that investors thought could benefit ended the day down. Companies like Clorox and Gilead Sciences. All three major indexes are down more than 16% on the week.

Some historic context: thirteen times the S & P has completed a 20% plunge in the last 93 years and in just two of those instances did the American economy not shrink within a year: 1987 and 1966. Among 14 recessions in that same time span, only 3 weren't accompanied by a bear market. The old adage: "the stock market isn't the economy," doesn't take into consideration consumer sentiment. So, now that you've all had mild panic attacks, let's just take a breath and evaluate what this could mean for your portfolio...and your sanity.

While there’s a degree of risk in any financial investment and we know bull markets historically happen more frequently and last longer than bear markets, there are no sure winners and no sure losers, either. How comfortable you are thinking about an economic recession and the impact on your portfolio may give you insight into your true risk tolerance. Risk tolerance isn't just how much you are willing to lose or hope to gain on your investments, but also how much uncertainty you can live with from day to day.

Everyone has a higher risk tolerance when things are up, but what happens when they aren't? Are you the type to sit and watch to stock ticker pass by all day? If so, does it fill you with dread or excitement? These are the kinds of questions you should be asking yourself consistently and not just in turbulent times. When would you feel anxious about your investments being down? If they are down 5%, 10%, 20%?....And for how long could your investments be down before you think about selling out of holdings to reduce the potential for further decline? Your answers to these sorts of questions will, in turn, help you invest in holdings that are right for you.

1. A Personality Test

The individual identity and psychological component of a risk tolerance assessment shouldn’t be ignored. Some of your risk tolerance can be measured, meaning that the amount of risk you can tolerate is based on factors like your age. However, you may simply dislike making risky investments. You'll be more likely to stay invested through difficult times if you are comfortable with both the upside and the downside possibilities. Your sentiment about the level of risk in your investments is critical.

2. What are Your Financial Goals? How much time do you need?

Retirement-focused goals aren’t the only goals that can impact your investment strategy. You may be saving for a house, setting aside funds for a child's education or operating a business. You need to make sure you have properly allocated funds for multiple, competing goals and that your funds are invested appropriately based on time frame, liquidity needs, etc. 

If you’re relatively young, you have plenty of time to ride out the peaks and valleys and take advantage of opportunities that arise along the way, as you're planning for retirement 20+ years out. You can likely tolerate a little more risk by design. If you have a goal you need to meet quickly (buying a home) or you are nearing retirement age, however, you may want to think more conservatively. 

3. Your Wealth and Income

If you have $5 million to invest, you can take more chances with a smaller portion of your cash than you can if you have $50,000. You should consider additional factors, such as the amount of debt you’re carrying, whether your personal ecosystem (job, family, health, etc.) is strong and stable. Who knows what these next few months could entail with regard to company lay offs, healthcare expenses, childcare expenses, the economic implications of business revenue slowing, etc. Make sure you have enough set aside for emergencies before you consider throwing funds into the stock market in the hopes of capitalizing on a quick rebound. What if a rebound doesn't happen as quickly as you hope or need? Speculation and attempting to time the market rarely works out.

4. Get Good Advice

Working with an investment adviser can reveal clues about your risk tolerance and help you map out an appropriate strategy. If you'd like to meet with us, you can prepare yourself for the discussion by taking the risk quiz below. You may find that you are not as risk averse or risk tolerant as you thought...or that your  portfolio isn't actually in line with your comfort level, time frame or goals anymore and needs to be adjusted. That's what we are here for.

Risk Score

This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.