The following is a guest post from Taylor Boyd, Vice President of Private Client Services, Burnham Gibson Wealth Advisors, Inc. Through high-touch personal interaction, he helps clients stay on course and accomplish their goals Boyd holds a bachelor’s degree in business with a dual emphasis in finance and marketing from Bethel University in St. Paul, Minnesota.
Markets are historically known to swing both up and down, but how does an investor manage those swings and use them to improve their position as a whole?
Volatility is a natural occurrence in investing, but preparation can have a major impact on the success of your financial plan.
Here are five things to review during a market shift:
1. Check your portfolio risk.
Handling risk properly is a standard practice for an effectively-managed portfolio. You want to consider how your investment mix has changed since you first created the account or if your goals and objectives have also changed since then. Carefully review your account positions to see if you are overbalanced into equities or perhaps have too much invested in cash or bonds.
Rebalancing your portfolio periodically mitigates the risk of having a disproportionately high allocation to any specific asset class. Rebalancing may seem boring and not useful during bull markets but it is the best defense to keep unwanted risk at bay. Rebalancing helps keep your account insulated from the ever-changing market—it is not about market timing but prudent management.
2. Understand your future income needs.
A market correction can put your income in jeopardy, so be sure to look at the time table of when you will need to draw income and adjust your allocation accordingly. The critical fact is that during a selloff in the market your need for income may force you to draw excess amounts of principal. This can lead to the portfolio being unable to sustain your desired income in the future. Although you may have the appetite for more risk in your portfolio, as you get closer to needing funds and ultimately when you begin distributions, it is prudent to reduce the potential volatility in your portfolio by reducing exposure to equities.
3. Review portfolio performance during past downturns.
While we all know that “past performance is not an indicator of future results,” past downturns can provide you with context as to the effects of a market correction. Look closely at how your funds have performed during past bear markets to understand how they might react in the future. You can start this review process by looking at the maximum drawdown of past markets. This looks at a fund’s performance from the highest peak to the lowest low during different market cycles, providing you with a gauge to assist in determining your comfortability with that potential outcome.
4. Think about the “worst case” scenarios.
Consider how much you are willing to lose and still stay invested in equities. It is easy to think of the best-case scenarios, but a wise investor will review the worst case as well.
Another consideration is what actions you will take if your portfolio drops by 20 percent or more. Will you panic and sell? Or will you stay the course and look for a broader recovery? A steep market drop may wipe out a lot of your gains, but also can provide a natural buying opportunity. Mapping out your investment plan in advance and determining what course of action you would take under different market conditions, helps assist in making non-emotional decisions when markets become volatile.
5. Remove emotion from your investing process.
A massive drop in the market is an emotional event. It’s not easy, but try not to panic and rush to safety by simply selling all of your funds. If you are acting on the previous four steps on a regular basis you will take great strides in removing emotion from your investing game plan. Panic and greed have no place in sensible investment management, these cannot be driving forces in your portfolio. Making plans while no emotion exists helps investors stay the course in achieving their goals and objectives.