If you’ve got any stake in the markets right now, chances are, you’re a little antsy.
Sure, it’s nice to see all those growing numbers in your portfolio, but let’s all be honest with ourselves: Just below the surface is that nagging whisper, “This can’t go on forever.”
Which begs the question: so what do we do now?
The New York Times’ John Wasik suggests now might be a good time to decide how much risk you are willing to accept. While I’d say this is a task you should perform in both good times and bad, if you haven’t in a while, there’s no better time than the present.
Let’s get started with a few suggestions he makes:
Determine Your Risk Capacity
Your risk capacity essentially is how much you’re willing to lose on any particular investment. For retirement purposes, you have to think about how certain-magnitude losses will affect the level of comfort you expect during life after work.
I recently attended a seminar in which the guest speaker gave the following example that gives you a good idea of the math you’ll need to determine this. For a single stock, say you owned shares at $100 that lost 50% of their value — it would take a 100% gain to make it back to “par.” So if you decide you’re willing to risk up to 50% of an investment, you have to do so with the belief that it could at least double again from that lowest point.
Of course, those who don’t want to risk that kind of price loss should instead consider high-quality dividend stocks like Johnson & Johnson (JNJ) and Coca-Cola (KO), which I personally think should appreciate in the future — but even if they remain flat or slide back a little, their sizable dividends can help counter the pain. Similarly, you might want to consider keeping a tight leash on any high-fliers you own — stocks like Netflix (NFLX) or Amazon (AMZN). Especially if you’re sitting on some profits in such stocks, and they’re looking frothy now, consider taking at least some of your money and putting it into more stable investments.
Consider Your Time Horizon
I’ve touched on this before, but it’s always worth coming back to the subject: When do you plan on retiring? Similarly, when do you plan to start taking Social Security? Both questions will affect your view on risk in the portfolio.
Let’s say a market downturn reaves 25% of your portfolio — there’s a huge difference between how that will affect someone who’s 30 and someone who’s 60. The former has much more time to recover from those losses, whereas the latter only has a short amount of time. Worse, with so much ground to recover, the likely path to redemption would be another helping of risk — higher-risk gambles that provide a lot of pop in just a little time.
So as you move closer toward retirement, make sure your portfolio better reflects the timing of your retirement, so you don’t find yourself in a gaping hole a steps from the finish line.
Put Together a Risk Budget
Wasik recommends completing an exercise done by many portfolio planners: an investment policy statement. Simply stated, its a road map of your risk, return and long-term portfolio objectives.
And no, you can’t just say, “I want to make a lot of money.”
A balance of growth stocks (for capital appreciation) and defensive stocks (for stability and income) is a long-term portfolio objective. How much of each asset class will allow you to sleep soundly at night? When you come to an answer, write it down, then abide by it.
But, don’t forget that times change. Your road map at 30 will look much different in 20 or 30 years. As your needs evolve, and as the market’s shape changes, you have to keep revising that map, lest you find yourself stuck with a suddenly faulty strategy that will have you fall short on your retirement goals.
The nice thing is, again, that if you haven’t given much thought to investment risk, you’ve got the benefit of a friendly market that likely has provided you a little breathing room. And it’s a lot easier to plan when you’re not under the gun.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he was long AAPL.