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Personal Investing: Why Now is a Good Time to Talk With Your Advisor 2008 October 7 © 2008, Libertiny Financial LLC
A detailed annual review of your investment portfolio that includes your retirement accounts and after tax investments is always a good idea. This review is critical to ensuring that your investment portfolio is tracking with your present comfort level for risk and investment return. Work with your independent financial advisor, financial advisor or stock broker—it’s what they get paid to do.
Tips for a good review: 1) Get everything in writing 2) Explicitly identify how much risk your willing to take and have your advisor identify the corresponding annual investment return you’re willing to take—including the likely gain and loss tolerance. Or, state how much investment return you want or need and have your advisor identify the amount of risk you should expect to take.
Example for Risk/Return Ratio Important Note: The following is an illustration. Your actual returns will likely be different. We strongly urge you to talk with your advisor before making any changes to your investment strategy.
If you’re still working, have 20 years left before you plan to retire, and are moderately comfortable with fluctuations in the stock and bond markets, you could be a Risk/Return level 3. This is on a scale of 1 to 5, with 5 being high risk/return and 1 being the lowest risk/return.
Having identified our risk level of 3, in an average year, we could expect a return of 7% on our money through a combination of dividends, interest, and increase in our stock and bond portfolio valuations.
The critical issue is the gain and loss tolerance. With a risk level of 3 in an average year, we could see our investments increase by 20% OR decrease by 5% (a 5% loss). That’s a peak-to-peak potential fluctuation of 25%. And that’s just for an average year.
Tip Ask yourself if you can sleep at night with the level of risk/return that you’ve identified?
Importance of Setting Caps for Gains and Losses in Advance The other important issue to determine with your advisor is defining a “Cap” or selling point for part of or all of your portfolio. This applies to both major market upswings and downturns. The importance of doing this in advance: 1) Peace of mind by having a plan in place. 2) Not getting caught up in the “I’ll just wait a few days longer cycle and hope that the market recovers.” 3) The ability to quickly execute a plan with your advisor.
Example of Caps for a Downturn Important Note: The following is an illustration. Your actual returns will likely be different. We strongly urge you to talk with your advisor before making any changes to your investment strategy.
Using the same “level 3” risk/return ratio as the example of Risk/Return Ratio, we could see a loss of 5% each year during an regular market cycle. However, we could see a significantly higher loss during a significant market downturn or recession.
The critical question to ask your advisor and to determine: At what point is too much of a loss? In other words, when does the loss become too much for me psychologically and mathematically to bear.
From a psychological perspective, continue to use the “can I sleep at night” question. We all have different levels of risk tolerance, especially when there is a major market event occurring. Select a percentage loss that’s acceptable to you.
An example if a strategy could be: “I’m going to sell 50% of my stock portfolio when I’ve had a loss of 10% of my overall stock portfolio’s value.” In this example, you’d sell 50% stocks and “park” your money in a relatively safe investment such as a CD, savings account, or a very high quality bond (not a bond mutual fund). The goal is not to make much money, if any, but to wait out the storm.
Mathematically, if your investments were to decline a large percentage, you may not be able to recover during your life time. Have your advisor calculate what percentage decline is unrecoverable for you and decide when you’ll sell your portfolio prior to reaching this point.
We’ve been focusing on market downturns, but you should also have a plan to sell for market upturns. Don’t be greedy. Sell when you’ve made your targeted profit and wait for a better opportunity.
Tip There’s no rule that says that you can’t wait on the sidelines and not participate in the stock or bond market.
Bottom Line The above suggestions are not “market timing.” They are simply proactive techniques to identify what you plan to do when a stock or bond market storm occurs. Just as your local fire department urges you to have a plan in place for your home, condo or apartment on what actions you will take in case of a fire. Advance planning is always a good idea. Now is a good time to review or develop a plan with your advisor. Do it today.
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