Why You Probably Need an Updated Investment Risk Tolerance Test

We’ve all heard it, we’ve probably said it and at some point since the Coronavirus pandemic began to change our everyday lives, most of us have felt it: These are unprecedented times, for sure. However, there are similarities between today’s market performance and bear markets we’ve experienced in the past. So, what can we learn from history? And how can it help us today?

Markets are volatile, but many people who started investing in the last decade or so may not have experienced what that actually feels like and know how they’d really cope.

They know now.

If the current volatility has made it hard to sleep at night, you may need a new investment risk tolerance test to see if you can lower the risk in your portfolio. It’s important that you don’t make an emotional reaction but a rational, thought-out decision, because the result can affect your future. Talk with your financial advisor, and consider history. While the past does not dictate the future, we can look to the past for insight into what may lay ahead.

The Historical Record

Stock market downturns are nothing new. It’s true that for the decade prior to 2019, the broad market averages enjoyed a record bull market run, on average. But bear markets also happen periodically, and so do less-sharp corrections. Stock market fluctuations are a normal and expectable part of stock market performance. The key is to look at performance over time.

When you do this, you can see that the stock market historically rises after a downturn, and climbs to new heights. For more than a century, U.S. investors have eventually not only recouped losses, but they have enjoyed profound gains.

On average, the S&P 500 increased 10 percent annually during the last 100 years. An annual return of 10 percent far outpaces that of bonds and cash instruments. It is also one of the few investments that outpaces inflation, which runs at an average of 2 to 3 percent.

Let’s take a more granular look at past stock market downturns.

The Great Recession of 2008-2009 sent the markets down sharply as well. The S&P 500 fell more than 37 percent in 2008. But it rose again every year, often in double-digits, through 2017.

The dot.com bubble burst from 2000 to 2002, when the S&P 500 dropped more than 9 percent, 11 percent and 22 percent, respectively. Before that, though, the market posted astounding yearly gains, including nearly 21 percent in 1999, 28 percent in 1998 and 33 percent in 1997. Valuations, as a result, were very high when the bubble popped, at 34 times average earnings. (The ratio of stock price to company earnings, often represented as a P/E ratio, is a common metric for valuing stocks.)

In 1987, Black Monday started a decline in the global equity market of 30 percent in 40 days. The decline was attributed to electronic trading.

In 1973-1974, oil shocks and inflation shook markets, along with high amounts of leverage. The S&P 500 dropped 15 percent in 1973 and nearly 27 percent in 1974.

In 1929, Black Thursday inaugurated a slide of 25 percent on the DJIA for the next three days. The resultant Great Crash is the granddaddy of all market declines. At the end of the next 35 months, the DJIA had lost 85 percent of its value.

Overall Lessons from the Historical Record

So, what are the lessons here? Markets dip, slide and even crash, but the overall record can be one of advancing stock market appreciation for investors who buy and hold long-term.

It’s important to remember the fundamentals of investing. Stock purchases are purchases of equity in a company. If the company continues to do well – producing products that customers want to buy, getting them to market and selling them – its revenue should rise. If it is well-managed, its profits should eventually climb. As long as its P/E ratio is reasonable, increasing earnings should lead to increasing stock prices.

As a result, selling into a dropping market is not a good idea. If you sell falling stocks, you’ve essentially forfeited the chance to recoup your losses going forward – and you’ve sold at a loss to boot.

Don’t plan to repurchase stocks in the companies you’ve sold once the markets start to advance again, either. Planning to buy rising stocks (or sell before a crash happens) are examples of market timing. Timing the market is nearly impossible, simply because humans aren’t clairvoyant. No one knows whether stocks will rise or fall on a given day, or when an uptick will prove to be the start of a trend.

Holding stocks through a downturn can have some advantages, as well. If you are reinvesting dividends, your dividends will purchase more stock when the equity is low than when it’s high. Plus, if you’ve had your eye on a stock and the price has fallen, it may be a good buying opportunity.

What Should Investors Do?

Volatile stock markets can be unsettling, but don’t panic.

Instead, work with a financial advisor to create a financial plan that works for you. This may involve starting from scratch or updating the plan you have. Your financial advisor should provide specific advice about the holdings in your portfolio and re-evaluate your risk. A current investment risk tolerance test and, if necessary, a changed risk capacity can help calm your nerves.

People vary in their ability to tolerate stock market and all other types of risk. If the recent declines have made you significantly uncomfortable, talk to your financial advisor about changing your portfolio to accommodate your risk tolerance.

Second, assess your investment and retirement portfolios. Pay particular attention both to your goals and your age. Have any of your goals changed recently? Financial plans should be reviewed at least once a year.

Your age is definitely a factor in portfolio asset allocation. Portfolios are divided between stocks, bonds and cash instruments (and may include other assets as well). Generally, stocks provide the most significant appreciation, but because of their known fluctuations, they are also riskier. Bonds and cash appreciate far less but provide stability and far less risk.

The closer you move to retirement, the larger percentage of bonds and cash you may want in your portfolio.

If you’re looking for a financial advisor in San Antonio, contact us. We’re here to help.

This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.

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