I currently have approximately $225,000 invested in the stock market. Most of this is in conservative stocks and bonds. Do you have an opinion about staying the course or liquidating all or part of it for a few months or years during this new crisis?
Your question is reasonable and addresses a common theme among investors. Naturally, a volatile market and unpleasant economic conditions will cause some concern. They may have people questioning whether they should do something different with their investments – like selling them all and keeping cash – to avoid potential losses.
However, making investment decisions based on what you expect the markets to do is often not the best approach. I always recommend staying the course, assuming you’re on a clearly defined course.
While I can’t directly advise you on what you should do in this scenario, I can educate you to help you make a decision.
A financial advisor can help you build an investment plan. Find a consultant today.
Pitfalls of trying to time the market
The biggest issue with exiting the market when things look tough for a while is timing.
How do you know when is the right time to sell? The simple reality is that you cannot know with any degree of certainty.
I will suppress my inner academic desire to explain this from a theoretical perspective. Instead, we can take recent history as a concrete example.
On February 14, 2020, the S&P 500 was at 3,380. But by March 23, the S&P 500, which is the most widely used broad measure of the US stock market, had dropped to 2,237.
Mid-February was the time to sell to avoid this drop of approximately 30%. But who knew that on February 14, when the information was useful?
The answer is nobody. A global health pandemic and widespread economic disruption were looming for American investors, but most of them didn’t know it yet.
Of course, you can estimate, model, suspect, postulate, guess or, if you’re really desperate, read tea leaves. But ultimately, you can’t accurately predict these kinds of things.
Disadvantages of attempting to re-enter the time market
The next step is knowing when to come back so you can participate on the bright side when the market turns the corner. If you had sold in February 2020, would you have known that by the end of March you needed to buy back? From that point, the S&P 500 has seen a relatively steady rise to close 2021 at 4,766.
Better yet, psychologically or emotionally, would you be willing after seeing the market sink more than 30% in such a short period of time? The answer is probably no. You probably would have missed at least some of that rebound.
And, of course, this cycle continues. The S&P 500 closed near 4,800 on January 1, 2022. To Sell or Not? Even within a single day, markets can go up and down precipitously. What a roller coaster.
Choosing a portfolio
Since investors cannot know for sure what the markets can do in a given period of time, they need a better way to make investment decisions that are not dependent on market timing.
My recommended approach, which is common among financial planners, is to ensure that investment decisions incorporate the investor’s risk tolerance and are aligned with the client’s objectives, including the appropriate time horizon.
Overview: This means choosing an asset allocation and maintaining a broadly diversified portfolio.
Choosing asset allocation
Your asset allocation is the balance between different asset classes such as stocks and bonds.
For example, you might have 70% stocks and 30% bonds. Or you can have 50% stocks and 50% bonds. You can select any other mix.
These asset allocations break down further into different types of holdings within classes, such as short-term and long-term bonds and US equities versus foreign equities. For our purposes, however, we can keep this example at a high level.
Your asset allocation determines how aggressive your portfolio is. The more shares you have, the more aggressive the portfolio will be. Thus, a portfolio of 80% stocks and 20% bonds will be more aggressive than a portfolio of 60% stocks and 40% bonds.
The more aggressive your portfolio, the more you can expect it to fluctuate. In rising markets, an aggressive portfolio tends to grow more than a conservative one. An aggressive portfolio drops more in a falling market.
Considering financial goals
You will also consider your financial goals in your portfolio choice.
Some questions you might ask yourself include:
Do I have a lot of time or will I need the money soon?
How much money will I need?
Are my goals flexible so I can delay or reduce expenses, or does the money need to be there when I need it?
These are the types of questions that come into play.
Keeping the Course
It is important to align your asset allocation choice with your risk tolerance.
That’s because once it’s set, you don’t change it based on market expectations.
In other words, if you determine that you are a conservative investor, you choose a conservative asset allocation. You shouldn’t switch to aggressive allocation when you think there’s a chance the market is about to take off.
On the other hand, which is what we’re talking about here with your question, you don’t move to a more conservative asset allocation when you think the future might not look so rosy.
That doesn’t mean you’ll never look at your investments again. You will need to rebalance as the market swings and moves your portfolio out of your intended allocation.
It’s also good to reassess your risk tolerance, because that can change with experience and education. It is advisable to update your portfolio in these situations, just don’t make the mistake of crossing the market timeline.
what to do next
Understanding your risk tolerance usually involves answering a series of what-if scenarios from a risk tolerance questionnaire. For example, you can answer the question “What would you do if the markets dropped by 30%?” with answers like “Buy the drop” or “Sell to avoid further losses”.
There are usually more complex questions as well. Your responses are then scored on a scale to provide an estimate of your risk appetite.
Bottom line: Assess your risk tolerance, set your goals if you haven’t already, choose an asset allocation based on your risk and goals, then stay the course.
Brandon Renfro, CFP®, is a financial planning columnist for SmartAsset and answers readers’ questions about personal finance and tax topics. Have a question you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAdvisor Match platform.
Investment and retirement planning tips
If you have specific questions about your investment and retirement situation, a financial advisor can help. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors that serve your field, and you can interview your advisor peers at no cost to decide which one is right for you. If you’re ready to find a consultant who can help you reach your financial goals, start now.
When planning retirement income, keep an eye on Social Security. Use SmartAsset’s Social Security calculator to get an idea of what your retirement benefits might look like.
Photo credit: ©iStock.com/gorodenkoff, ©iStock.com/ArtistGNDphotography
The post Ask a Counselor: I Have $225K in the Stock Market. Should I take out some of them? appeared first on SmartAsset Blog.