A common question in surveys that attempt to judge an investor’s risk tolerance inquires about the person’s assumed response to a significant market decline. It generally asks: If your investments declined sharply, would you:
A) sell and wait for better market conditions
B) stay the course and hope the decline is temporary, or
C) invest more at lower prices
Up until 2000, comforted by historical precedent that markets recover and go on compounding gains before too long, many investors were happy to stay the course. But since then, investor patience has been tested because it is unclear how much time staying the course actually requires to recapture previous market highs.
This presents a challenge when the recovery does not match the time frame of a retiring or already retired investor. The three options presented in the risk tolerance question also do not present a meaningful response to address the situation in the context of your goals and your financial security.
Michael Kitces, a CERTIFIED FINANCIAL PLANNER™, and frequent conference speaker in the financial advisor industry, presents a more meaningful way to plan for the possibility of a significant decline in assets. He revises the question, as follows:
“If your portfolio experienced a sharp decline and you were concerned it might not recover in time, would you
(A) spend less and save more now,
(B) spend less in retirement so you don’t need as much in assets, or
(C) delay your retirement date”
These options present a real, proactive response to an unexpected crisis. And Kitces notes, “it is simply based on what you would do if you were CONCERNED that the portfolio might not recover in time.” If your time horizon is still long and there is less concern that’s one thing. But it’s best to address concerns before they become problems and the only options remaining are to make unwelcome lifestyle changes.
The way to understanding the potential impact of market events, or significant changes to income and saving ability, is to have a thorough plan that goes beyond the ideal investment mix for your prescribed level of risk tolerance.
With the plan in place you will be less likely to fall victim to the whims of a moody market and react repeatedly to the shifting landscape of the global economy. The plan gives you the ability to apply “what if?” considerations (revising the timing or size of goals, working longer, waiting to claim Social Security, etc.) so that you can make informed decisions when the world around you deviates from your ideal scenario.
~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA