Uncertainty around recent global events and the associated capital markets volatility has caused some investors to wonder what they should do with their investments. To that we say, nothing.
What worries us as investors is not the quantifiable risk inherent with investing but the uncertainty associated with that process. In other words, if you can calculate the odds or at least estimate them reasonably well like it is with predicting long-term portfolio performance, that aspect of systemic risk is easy to handle. The issue is with being able to calculate the odds of an impending market crash and the uncertainty associated with it that makes us abandon our well-articulated plans. We all intuitively know that market corrections and crashes aren’t an IF but a WHEN; it’s just that we can’t accurately predict the WHEN and HOW of those events. And that as always is the bad news.
The good news is that historically, we have been compensated extremely generously by the markets to endure its inherent uncertainty. The even better news is that we can prepare for uncertainty by orchestrating portfolios designed to not only weather those intermittent storms but to take advantage of them if and when they occur and recur. But to do that effectively, you need to be extremely honest with your ability to handle pain. How much paper losses can you handle in your investment portfolios in the near-term without abandoning whatever plan you have in place? Because abandoning a plan is worse than having no plan. Just ask any market participant that bailed out during the 2008 credit crisis or during any other such events in the past that coincided with a market crash. That investor will likely never be made whole again.
So how can you quantify your pain threshold? The gut check test below should help you choose the amount of volatility you can handle by balancing the two primary ingredients of any financial plan – the equity or stock versus fixed-income or bond allocation.
But that of course is not all. Your time-horizon and your ability to meet your goals with the income you need also plays a big role with the portfolio-mix you end up with. And no one wants their portfolios to ever go down but then you are not likely to meet your goals whether it be with buying a house or sending your kids to college or to be able to someday retire. Unless the windfall Gods smile at you with enough capital that allows you to survive on whatever the bank accounts are yielding these days.
So regardless of what happens to the markets in the near-term, don’t change anything. As long as the plan you have in place takes into account your near-term goals and your long-term aspirations, stick with it. Because an abandoned plan is….you guessed it.
Image credit – Christopher Brown, Flickr