Should you be thinking about volatility? Probably.
By Carl Trevison and Stephen Bearce
When the stock market is on the rise, investors can fall into the trap of believing the good times will never end. But in all probability, market volatility will return, and chances are it’ll be when it’s least expected.
Rather than waiting for it to happen and risking the possibility of panicking and making costly investment decisions, you may want to think about volatility during those good times. That way, you can be strategic rather than emotional about dealing with it, which may lead to better outcomes.
What type of investor are you?
What you should be considering now depends on which of these describes your current situation:
- You have an investment plan.
- You don’t have an investment plan.
Let’s begin by addressing type two investors.
Quite simply, if you don’t have an investment plan, you should think about creating one, and here’s why: A well-thought-out plan is built around what you’re investing for (goals), how long you have until you need to tap into your investments (time horizon), and, most important for this topic, the amount of market volatility you’re comfortable with (risk tolerance).
Taking these factors into consideration, your plan should include a strategic asset allocation, which is how your portfolio is divvied up between different types of investments — primarily stocks, bonds, and cash alternatives.
You may be the type of investor who takes market volatility in stride. In that case, you likely have a relatively high risk tolerance. On the other hand, volatility may make it hard for you to sleep and cause you to panic, which would mean your risk tolerance is probably rather low.
If you’re the second type of investor, a larger portion of your asset allocation would likely be in bonds, which historically have been more stable than stocks. However, along with that relative stability generally comes significantly lower returns.
The potential benefit of having an investment plan is you may be able to do a better job of dealing with volatility because you’ve “baked it into” your plan so you should be better prepared for its possible impact and your reaction to it.
What if you already have a plan?
If you have an investment plan, you should be thinking about whether your portfolio is currently aligned with your strategic asset allocation.
While it might be nice if you could set and forget your asset allocation, the fact is over time market activity can cause your investments to drift away — sometimes far away — from where you want them to be if you don’t keep an eye on them.
For example, a hypothetical 50% stocks, 45% bonds, and 5% cash alternatives portfolio could become a 60% stocks, 35% bonds, and 5% cash alternatives portfolio without you realizing it. While that “new” portfolio may provide better returns, it’s also likely to fluctuate more in value if the market becomes volatile. In other words, you could be exceeding your risk tolerance without being aware of it.
To help avoid this situation, consider periodically rebalancing your portfolio when necessary, which may require selling some investments and purchasing others to bring it back to your intended asset allocation.
Because creating a plan and keeping it in balance can be complicated, for help you may want to turn to a financial advisor with the necessary tools and experience.
Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.
This article was written by/for Wells Fargo Advisors and provided courtesy of Carl M. Trevisan, Managing Director-Investments and Stephen M. Bearce, First Vice President- Investments in Alexandria, VA at 800-247-8602.
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