Before you do, ask the right questions
North America’s stock markets are at or approaching bear market territory – that is, where their stock indexes have lost 20% or more from recent highs and have not quickly bounced back. Only Toronto’s S&P/TSX Composite, supported by a strong energy sector, has remained in “correction” – that is, down 10%+ from recent highs. And typically, this is when you start hearing from pundits, media talking heads, and various analysts that maybe this is the time to start “shopping for bargains” or “look for oversold stocks,” or similar kinds of sentiments. So should you in fact start buying stocks now, or shifting cash back into equities if you lightened your allocation when markets started sliding?
Ask the right question
The answer is that no one knows. Market bottoms are obvious only in hindsight, and timing market entry and exit points with any degree of accuracy or consistency is virtually impossible, even for the experts. So the question isn’t really about whether to “get back into stocks” now. It’s whether you are allocating your assets properly in your total portfolio in the first place, in accordance with your true tolerance for risk.
When clients ask me whether now is the right time to get back into the stock market, I usually tell them that anytime is the right time to get into stocks. In fact, you should always be in stocks. I then add that you should also always be in bonds. And in cash. It’s the proportion that counts, and how you manage it. In other words, you should have a plan.
I’m talking here about proper asset allocation, one of the keys to success in personal money management. Basically, this means that you determine what kind of investor you are, what your financial objectives are, how much risk you can really withstand, and then create a portfolio of investments that reflects that profile.
When you have a planned asset allocation strategy that you stick to, you’ll feel more comfortable weathering the inevitable stock market downturns, like the current one. Yes, the equity portion of your portfolio will plunge right along with the market. But your bond holdings are likely to soar, and your cash won’t lose value, offsetting losses in equities. That’s called mitigating risk.
Considering the risk
Many investors, particularly novice investors, have a wildly inflated sense of their tolerance for risk. In a bull market, novice investors often claim, “I can live with the risk.” But can you really? Remember, a 20% loss on a stock portfolio of, say, $500,000 is $100,000. But your portfolio would have to climb 25% just to get back to breakeven – and that usually takes much longer than the initial drop. Could you really live with that kind of fluctuation?
The key to dealing with risk is to ensure that your investment portfolio aligns with your tolerance for risk. With moderate risk-tolerance, for example, you might weight your portfolio 60% equity and 40% fixed income. The equity component is there to generate longer-term growth (and perhaps some dividend income); the fixed-income allocation is for safety and income. It times of market volatility, you would adjust allocations in a band, reducing equity and boosting fixed income and cash from 60/40 to 50/50 or even 40/60.
Remember that when you create an investment strategy, you’re doing it with the objective of increasing your wealth. But you want to do that while staying in your risk comfort zone.
Instead of switching in and out of assets based on the headline of the day, I recommend clients be in stocks, bonds, and cash at all times. It’s a matter of degree – allocating your asset mix according to your objectives and tolerance for risk. The stock market plunges 20%? So what? Your portfolio might slip only 10% if you’ve diversified properly and mitigated overall risk. Investing is a long-term business, and you’ll have a much greater chance of success in the long term if you have a plan…and stick to it.