It’s no secret the stock market can be very unpredictable. However, by avoiding these common investing pitfalls, you can better protect your portfolio from market volatility.
DO NOT take unnecessary risks.
Risk tolerance and risk capacity are two ways to view risk. Your risk tolerance is dictated by what you’re comfortable with. Risk capacity, on the other hand, is measured by how much risk you're able to take on with your investments, based on your goals.
Managing risk and deciding how active you need to be can be determined by your answer to these two questions:
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- Are you comfortable seeing your portfolio experience significant drops?
- How much can you, quantitatively speaking, afford to lose?
For instance, Person A might not be able to stand to see their portfolio drop by 20% (risk tolerance), but based on their savings or goals, they can afford more exposure while attempting to achieve higher returns (risk capacity). Person B, on the other hand, has no problem seeing their portfolio drop by 50% (risk tolerance), but the amount of capital on hand prevents them from taking more risk due to their overall goals (risk capacity).
Determine what your goals are and understand what you need to do — how would a market downturn impact your ability to meet those goals? The key is to remain realistic about your risk, because one of the biggest mistakes we can make is not realizing how much risk we can take on and realizing too late that we had too much risk. Be brutally honest with yourself about how much intermittent loss or paper loss you are capable of accepting.
DO NOT be overly emotional.
We often talk about not making emotional decisions with your money, but in reality, everybody does. It’s very easy to lose sight of the big picture and what needs to be done long-term, especially with a news cycle that alerts and updates us with 24/7 coverage. While conventional wisdom tells us to buy low and sell high, our primal, gut instinct says otherwise, especially when external indicators tell us that we need to panic, panic, panic!
Take a deep breath and look at your long-term goals. It all goes back to understanding and being realistic about your risk tolerance and capacity. Knowing what kind of risk you’re comfortable with will help you keep a steady head in spite of whatever twists and turns the market may take.
DO NOT rely on a particular product or asset type.
As the old saying goes, don’t put all your eggs in one basket! Just because an investment has been fruitful so far doesn’t mean it always will be.
For example, cryptocurrency was once a hot commodity. There were folks who invested small amounts in an asset like Bitcoin and saw their money grow many times over, even to multiple millions. But as we have seen in recent months, that hot iron has cooled significantly. It’s a big mistake to not be diverse all the time!
Diversification is not something that necessarily improves your returns. If we had a crystal ball, we would put all our money into the “best” investment. People are always looking for the silver bullet — the next Amazon or Google — but we don’t know! We diversify to give ourselves a better chance to take advantage of investments with upside while preventing us from making panicked decisions when markets experience dips in performance.
DO NOT remain static.
Oftentimes, I see investors rely on their gut instinct when it comes to knowing when to get out and take some risk off the table. However, it’s very rare that their instinct lets them know when the right time to get back in the market is. Instead, they sit on the sideline, sometimes for years! They oftentimes end up missing out on much of the market's rebound and return to gains.
Actively managing risk in a portfolio is OK. However, taking risks off the table doesn’t mean taking everything off. You can hedge. Make sure you have rules for re-engagement in place — that is, a defined plan for when and how you will get back in.
When positioning yourself within the markets, try to be a predictor of the future. The stock market today reflects what is anticipated for companies or the economy several months from now, not necessarily where it is today. Block out the noise of poor economic headlines today because much of the market is already looking ahead six to 12 months.
You need to look at both the market volume and where your chosen security is vs. their moving averages. The 200-day moving average is a good long-term trend indicator. If a stock is below its 200-day average, that’s a pretty bearish indicator — it’s likely not going anywhere to the positive in a major move right now.
On the flip side, if it’s above the 200-day average, that normally indicates a bullish market with momentum! If your chosen stock or index is below its 200-day moving average, you may want to consider something safer or an alternate position, such as Treasuries or cash. That’s a single indicator to look at and should always be viewed in the context of others, but it’s something that is repeatable and reliable for doing analysis.
The more volatility you can eliminate from your portfolio, the better you will sleep at night!
At the end of the day, there’s no magic bullet combination of investments and assets. However, by playing it smart, being strategic and, of course, consulting with a financial adviser, your portfolio can thrive in even the most uncertain market conditions. Much like I do with my clients, a good adviser should continually stress-test their clients’ portfolios to make sure they stay on track for long-term success.
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