What are some common mistakes you've seen during a volatile market?
There are many pitfalls that lead investors to make costly mistakes. One common scenario is making a financial decision based on emotion. It's human nature for our emotions to be stronger when our money's on the table. However, prudent financial decisions shouldn't be based on emotion. Instead, I like to think of my clients' portfolios as a business. We need to plan how we're going to make money and what risks we may encounter along the way. And when things get tough, we don’t just throw in the towel and close the business.
Do you know investors who lost money by trying to avoid a market downturn?
Although I advised against it, one of my clients sold everything to cash in mid-March 2020 during the COVID-19 crash. A few months later, the stock market came roaring back. If this investor had stuck to the financial plan and not allowed emotions to control their financial decisions, their portfolio would have recovered the losses and increased the balance by several hundred thousand dollars as a result of rebalancing back to the advised target asset mix.
If the market heads into a recession, how might an investor pivot?
A recession doesn't need to change your risk tolerance or investing approach. You should continue to invest regularly and try to increase the amount you're saving. Your overall portfolio asset mix should determine the percentage of your money invested in stocks, bonds, and short-term reserves. It's important to review your asset mix periodically. If your portfolio percentages are off target by more than 5%, it may be appropriate to rebalance. In the current rising interest rate environment, it's important to remember that each part of your portfolio serves a specific purpose. Stocks provide growth and offer a decent inflation hedge over the long term, such as over 10 years. Bonds provide an income stream and tend to decline less than stocks, part of the diversification benefit. Cash should be held in a measured way, not to exceed the target level of your emergency fund or short-term spending goals (e.g., roof, car, house, or other expenses in the next 2 years).
As a reminder, your bond investments will start to pay higher dividends each month, which is the source of most of your bond returns. I like to compare bonds to rental properties. Until you're planning to sell the rental property, its value doesn't matter. You just need to own the rental (or bond) and collect the rent check each month. And, by the way, the rental income will continue to increase over the next few years because of the higher interest rates.
