What is the right level of risk for you?
Not surprisingly, risk assessment is a very personal decision. What’s right for an experienced, aggressive investor with deep pockets is surely not a good fit for a novice. Stocks tend to be riskier than bonds, although that’s not always the case.
While we like to think, as investors, we have a handle on how much risk we can handle, it’s when the markets get tough that we get a true feeling for where we stand. Reaching for the “sell” button in a market correction is rarely the right move—nor is hitting the “buy” button repeatedly when it looks like the market will never again hit a bumpy patch.
It helps to look at psychology.
Recency bias—the belief that recent events will continue into the future—is what derails many investors into ignoring their well-thought-out plans. That could include buying or selling thoughtlessly or in a knee-jerk response. Confirmation bias—seeing new evidence as confirmation in your existing beliefs—could lead you to maintain or increase positions that simply aren’t as valuable as you think. Another challenge is thinking that you are seeing things in the market that others are overlooking—and believing you can time the market or chase performance.
The better course of action is to take an honest look at your risk tolerance, and focus on long-term objectives. If you find that the market action is testing your resolve, it may require reassessing your goals. Risk thresholds, investment philosophy, and time horizons are in constant interplay with your actual objectives, whether they be growth, income, or asset preservation.
Ultimately, risk tolerance should be tied to reaching your objectives, not what feels good or bad in the moment. If you place too much emphasis on returns, while ignoring risk, your long-term performance will undoubtedly suffer.
Navigating volatility requires several components: First, be broadly diversified in your holdings. Second, follow the old Warren Buffett adage of being cautious when others are greedy, and greedy when others are cautions. Third, understand exactly what’s in your portfolio, and why you’re holding it. And finally, don’t be afraid to sell your losers—and don’t try to catch any falling knives.
