A couple of weeks ago we started a two-part series to discuss recommendations in volatile markets. As promised, here is installment #2 of things to do in volatile markets.
3) Diversify a bit more. There is probably not enough written about diversification in portfolios, but it has been proven that superior returns are directly related to diversified portfolios. From my experience, the problem with portfolios that experience volatility beyond the investor’s tolerance are the ones that are not diversified enough. This can happen for many reasons, but the quickest way to address and/or fix the problem is to have the portfolio reviewed by your advisor. I won’t use this segment to discuss variance, covariance and correlation but suffice to say all these terms are important when it comes to diversifying your portfolio.
TAKEAWAY: Building a diversified portfolio will dampen or lessen volatility in your portfolio.
4) Bifurcate risk: What can you actually quantify? Consider your appetite for risk. Risk tolerance has two crucial aspects as it relates to your investing. The first is your ability to assume risk, and the other is your willingness to assume risk. Briefly I’ll say that although your ability to assume risk could be high (e.g. because you have high income or great wealth) your willingness to assume risk could be very low. The latter is more psychological based (see point #2 on biases) and largely formed from our experiences. Make sure your risk tolerance and thus your investing style reflect both aspects. Here is a link to a really good risk survey that you may take and get some feedback from your current advisor about.
TAKEAWAY: Understand what you can handle and have your plan built around that.
5) Consider your total wealth, not just your financial assets. Many investors today do not have a plan that considers their “human capital” as well as their financial capital. Human capital is simply defined as the value of your future earnings. Obviously the younger you are the more you have. The point I’ll make here is that a financial plan that doesn’t consider this major source of wealth for most Americans is an incomplete one. Also worth noting is the fact that younger investors have longer investment horizons mostly offsetting the effects of temporary (be it current or not) market volatility.
TAKEAWAY: Your entire financial picture = your future earnings + your current savings.
This recommendation list is by no means inclusive of all the strategies one can undertake in volatile markets. Other important strategies include dollar cost averaging and tax-loss harvesting (see our Aug 10th post for more info on the latter). And more than anything, count your blessings and be thankful for what you have. If you are investing for the long haul you will most likely just remember this time as a blip on the radar.