February 26, 2021

Long-Term Stock Plans Help to Avoid Impulsive Moves

This is particularly worrisome for people who are nearing retirement, as well as those who have already left the work world, many of whom are probably spending a fair bit of time wondering if the world markets have suddenly become a riskier place.

When you need to begin withdrawing savings, the stock market valleys can appear deeper and more turbulent than the ones you experienced earlier in your career because there is often little time to recoup your losses.

“What changes, and very radically, is risk perception,” said Dave Yeske, a financial planner in San Francisco. “The scariness of short-term volatility disproportionately blinds us to the long-term scariness of inflation,” he added, saying that the recent inflation rate of 3.6 percent would erode your purchasing power by half in 20 years.

The latest bout of volatility is no exception.  The summer was punctuated by rounds of dysfunctional politicking and then, on Aug. 5, the unprecedented downgrade of the United States credit rating. Concerns about a double-dip recession continue to linger, while the debt crisis in Europe is another wild card.

 Not surprisingly, the markets reacted. Look at a stock chart during the week after the downgrade: the zigs and zags form a distinct W, which took shape when the Standard Poor’s 500-stock index plummeted nearly 7 percent, and then, in the days following, rose about 4.7 percent, gave up 4.4 percent, then rose 4.6 percent once again.

Further market gyrations are inevitable. So to protect your portfolio from yet another risk — your emotional impulses— during these unsettling times, you might consider reassessing whether your money is invested in a way that you can truly handle for the long haul.  Start by trying to answer these questions:

HOW MUCH RISK CAN I TOLERATE? Though the most recent downturns are painful, they have served a purpose. “It did provide a nice stress test for investors,” said Fran Kinniry, a principal at Vanguard’s Investment Strategy Group.

How did you do? Were you able to ride out the crash in 2008 and 2009 (or perhaps even the debt ceiling debate) without touching your investments — or did you fold and go to cash? If it’s the latter, then you were invested too aggressively, experts said.

“If they were at 60 percent in stocks and 40 percent in bonds going into the bear market, and sold during the downturn, then that is above their tolerance for risk and they shouldn’t go back to the level,” said Rick Ferri, author of “All About Asset Allocation” and founder of the money management firm Portfolio Solutions. “Perhaps 50-50 or 40-60 is more appropriate, that is if they need to take that much risk based on their situation.”

At financial planning firms across the country, advisers have been re-evaluating their clients’ stomach for volatility. “We moved a lot of our retirees that exhibited lower risk tolerance during the last crash to lower equity exposures once the recovery was well under way,” said Rick Kahler, a financial planner in Rapid City, S.D. “In the last year, many wanted to return to their previous portfolio that had the higher equity exposure, and we discouraged them.”

That sort of flip-flopping can be attributed to a behavioral phenomenon known as recency bias — the tendency of investors to weigh recent events more heavily than those in the past.

Though advisers say that many of the risk tolerance questionnaires available on the Web are an overly simplistic gauge, many of them use FinaMetrica, a 25-question tool that combines psychology and statistics and generates an investor risk profile illustrating where they stand relative to others. While it is geared for advisers (and costs $45 for consumers), it could prove to be an educational exercise, or serve as a conversation starter for couples with different outlooks.

HOW MUCH STOCK DO I NEED?  The amount of stock funds you can tolerate may not necessarily match what’s recommended to reach your retirement goals. (But you generally want to take as little risk as you need to reach those goals.) The optimal allocations will vary depending on your specific circumstances and how much money you need to withdraw for annual expenses not covered by Social Security, pensions and other income sources. Because retirement does not come with a do-over option, it often pays to visit a certified financial planner, particularly one that charges an hourly rate or a flat fee, to help you sort this out.

Still, even among investment professionals, the recommended allocations tend to differ. Consider the varying allocations of target-date funds — whose investment mix becomes more conservative as you age — for people who recently retired or are nearing retirement.

Schwab’s Target 2010 fund, for example, holds slightly more than 38 percent in domestic and foreign stocks, while Vanguard’s 2010 target-date fund is nearly 46 percent in stocks. Fidelity’s Freedom 2010 has 47 percent, and  T. Rowe Price’s Retirement 2010 fund has 53 percent. Meanwhile, a Vanguard fund for people who have already retired or are over the age of 69 has a stock allocation of 30 percent.

Mr. Ferri, the author and money manager, suggests some investment mixes in his book that could serve as a starting point. For example, a person who is about three to five years from retirement and has a moderate tolerance for risk may consider a diversified portfolio evenly split between stocks and bonds, he said, while a conservative investor may keep only 30 percent of the portfolio in stocks.

Once retired, moderate investors may dial down their stock allocation to 40 percent, Mr. Ferri said, while more aggressive investors may still decide to keep 60 percent in stocks. “These examples probably cover 80 percent of retirees,” he said. “There are some people who can and should be more aggressive, and those that should be more conservative. It all depends how much they have saved and whether that’s enough, or if they have much more than enough and are really investing for someone else.”

Article source: http://feeds.nytimes.com/click.phdo?i=06268cfa828940004b56f2acc1fe757f

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