Ready for Stock Market Risk? Go Back to Basics to Find Out
How confident are you in your ability to make the right choices for your retirement investments?
Last year, when the Federal Reserve Board released its "Report on the Economic Well-Being of U.S. Households" (based on surveys from 2015), it found that 49% of all respondents with self-directed retirement savings were "not confident" or only "slightly confident" about making the right decisions.
That we're in the ninth year of a bull market is only adding to people's doubts about what to do next. Even experienced, hands-on investors can't help but ask how long the record-setting good times can last. Should they stay or should they go?
If you're feeling uncertain about your plan - or if you're just getting started -- it's always good to go back to the basics to determine how ready you are to deal with any future market fluctuations.
1. Start with the big picture.
Think about your time horizon (how long you have to invest), your net worth, income, expenses and then -- keeping all that in mind -- how you feel about risk.
Most advisers talk about "risk tolerance" and put that in terms of a percentage. "Can you deal with a 10% drop?" they'll ask, and because 10% doesn't sound like much, most investors will say yes.
I prefer to talk about real dollars. If you have a million-dollar portfolio, for example, and I ask if you're OK with losing $100,000, your mindset probably would start to shift a bit. Taking it a step further, I might ask how long it took you to save that $100,000, and how many years of income that much money might have provided in retirement. This gives a much clearer picture of the magnitude of a major market fluctuation.
2. Next, think about what you want to accomplish at this stage of your life.
If you're looking to grow your money, you may want to shoot for higher returns. Just remember, the higher the return on your money, the more risk you'll have to take to get it.
If you're close to or in retirement, you're likely more interested in the return of your money. With an income-focused portfolio, you won't see the big highs and low dips, but you should see higher yield and/or a consistent level of income.
You may wish to design a plan in which you have both a return of your money for income and a return on your money to help outpace inflation.
3. Finally, put it all together, keeping these questions in mind:
- What's your fluctuation comfort zone? How comfortable are you with the prospect of losing money in a market correction or downturn?
- How much can you really afford to lose? Don't forget to transition down the amount you set aside for growth as you get closer to retirement.
- Are you confident in your financial strategy? Is your strategy clearly defined, and does it coordinate with your income plan?
- Have you established your "uncle" point? Experiencing some discomfort when the market drops isn't the same as knowing when you're truly done. At what point will you say, "You know what, I'm out. I can't take it anymore. I'm selling." Knowing this number can keep you from making knee-jerk decisions based on emotion, but also from hanging on too long if the ship is going down.
A knowledgeable financial professional can help you draw up a realistic plan that will help you reach your retirement goals. But it's up to you to clearly and honestly establish your boundaries. If you find yourself fretting about the moves you're making in the market, take some time to re-examine your motives and your mindset.
Kim Franke-Folstad contributed to this article.
SEE ALSO: What Investors Need to Know About Risk