Years like 2017 make investing look easy -- many who took risks in 2017 were rewarded. Volatility remained low for much of the year, and in general, as of this writing the more risky investments appear to be performing at a higher level than your more conservative investments. Sounds like a textbook answer regarding how to invest, but as we all know this paradigm can be turned upside down in a heartbeat by matters beyond control of any investor.
Legal and compliance professionals like to ensure that we all know that past performance is no guarantee of future results.
One thing that past performance does illustrate, however, is that markets will go up and markets will go down. Markets also seem to illustrate that no one person, entity or method seems to have a lock on capturing all of the upside any market has to offer, while limiting or eliminating the downside.
As a result, a good starting point for you when it comes to taking a deeper look at your collection of investments is to understand how much risk you are taking in your portfolio.
This analysis cuts both ways. The first, and most commonly considered, is the aggressive risk taker who should understand that losses from their investment choices are more likely than they may be for the very conservative investor. That investor may expect larger gains than a conservative investor, but should also understand that this will not play out as the theory may suggest in every year.
Conversely, a very conservative investor may be taking no risk of loss by investing in guaranteed cash instruments with no risk of loss. This doesn’t mean that this particular investor has no risk in their financial life. Perhaps the earnings rate on their guaranteed safe investments is very low, maybe even less than the rate of inflation, thereby reducing future purchasing power.
This isn’t intended to be a warning that markets will be going down – but on the other hand, it is.
It’s just that no one really knows when less rewarding times will be upon us.
What this is about is to help you better understand that just because you saw your 401K plan rise materially this year, it won’t be like that every year.
Stress test your portfolio to see how it fared during previous market downturns. If your holdings may have suffered by 30 or 40% to the downside under previous market meltdowns – what would make you think that it couldn’t happen again?
It can, and you should assess at this point in your life whether this is the type of volatility that you may be willing to live through again. If you have a long-term time horizon and believe in capital markets – the answer may be yes. But if you are on the doorstep of retirement, and getting concerned about portfolio losses – then maybe your answer is no.