We often get the question “Is now a good time to get in the market?” My answer is different for each client, because it depends on the following:
Let’s differentiate.
Risk Tolerance – this is your willingness to take risk. This is about emotions, and there is no right or wrong answer. It’s subjective.
How do you respond emotionally to seeing your investments drop in value? If you had a $1,000,000 portfolio invested in stocks, and your portfolio went down 30% to $700,000, how would you respond? Angry, upset, perhaps confused – but would you act on those emotions and sell your investments? Or do you view it as an opportunity because investments are now “on sale” as I like to put it?
I stole the following phrase from someone that I use with new families we work with, and it holds true to this day. “Sometimes you will be so mad, you will want to throw a brick through my office window. But when you do, make sure you tie a check to it, because that’s when we want to buy.” In the investing world, what’s comfortable is not always profitable.
Risk Capacity – this is your ability to take risk. This is not about emotions; it’s objective. What is your time horizon, i.e. when will you need the money? Will you be adding or subtracting from the portfolio?
Example #1: Let’s say a 30 year old employee received a cash bonus of $100,000 for their performance and was planning to use this money as a down payment on a house one month from now. This person’s risk capacity is effectively zero. Why? Because they have a short time horizon (one month) and needs 100% of that money. He cannot afford to invest his money in the market, because he needs it so soon. What happens if the client invested the money and in one month, he goes to sell the investments to get the cash? If the market is up 10%, this turns out great. If the market is down 10%, he will have to sell at lower values and receive less cash. No more down payment.
Example #2: Same person as above. Receives a $100,000 cash bonus for his performance. But this time, he or she decides to continue renting and wants to use the money when he retires, 30 years from now. In this case, the investor’s risk capacity is significantly higher. They have the ability to take on risk to earn a higher return. Why? Because the investor has a long time horizon (30 years), and will be contributing to the account over the next 30 years. As this investor comes closer to needing the cash, his risk capacity comes down.
Your risk tolerance and risk capacity are not set in stone. They will change over time. Let’s say you have the extra cash to invest, no immediate needs for the cash, and are willing to deal with the waves of the market. In this case – consider taking action sooner than later. No one knows where the market is going. Although it can be entertaining, don’t listen to the famous market predictions on CNBC. Define your own risk numbers and invest accordingly.
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Peter Lynch, legendary investor
Investing involves risk and investors may incur a profit or a loss. Past performance may not be indicative of future results. The examples used are hypothetical illustrations and are not intended to reflect the actual performance of any particular security. Future performance cannot be guaranteed and investment yields will fluctuate with market conditions.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of the author and not necessarily those of Raymond James.
