History has shown that successful investing requires discipline, patience, and an ability to manage risk. When volatility enters, emotions and investment risks run high. It can be easy to lose focus on your investment strategy. To help you overcome these challenges, here are some important items to keep in mind:
Do You Know the Risks?
Investors need to remember that markets can be turbulent, some risk is systemic, and that preparing for potential declines is essential. There can be a strong temptation to pull out of markets when they become volatile. However, instead of acting on this temptation, it may be smarter to adjust your investment approach and have a long-term risk management strategy. By remaining flexible, you might be able to take advantage of opportunities while managing risks.
- Interest rate risk is the potential for investment losses resulting from a change in interest rates. If interest rates rise, for instance, the value of a bond or other fixed-income investment will decline.
- Market risk is the risk that arises from movements in stock prices, interest rates, exchange rates, and commodity prices. Market risk is distinguished from credit risk, which is the risk of loss from the failure of a counterparty to make a promised payment, and from a number of other risks that organizations face, such as breakdowns in their operational procedures. In essence, market risk is the risk arising from changes in the markets to which an organization has exposure.
- Currency risk is sometimes referred to as “exchange rate risk” and arises from the change in the price of one currency in relation to another. Investors or companies that have assets or business operations across national borders are exposed to currency risks that may create unpredictable profits and losses.
A Risky Balance
A variety of factors may cause one to act more cautiously than normal, including ongoing global uncertainties and fears about the overall economy. This can lead to investors flocking to low-risk investments despite misalignment with their goals. Remember, while minimizing risk can feel like a safe move, you could miss out on opportunities as a result.
Another mistake can be creating a portfolio that doesn’t reflect your overall risk tolerance. When building a portfolio, the objective is to take on the amount of risk that aligns with your goals and time horizon. This is often accomplished through a diversified allocation of assets that may help manage your portfolio’s risk. It’s important to remember that asset allocation is an approach to help manage investment risk. It offers no guaranteed protection against investment loss. Periodically stress-testing your portfolio will help you stay aligned with your goals.
Leave Emotion at the Door
When markets swing, emotional decision-making can wreak havoc on the most carefully designed investment strategies.
Fear and greed can drive anyone’s financial decisions. Fear can cause us to abandon an investment strategy when the outcome is not what we want, while greed can cause us to chase investment fads and assume too much risk. As you invest, you can support your strategy by attempting to manage these emotion-based decisions.1
An investment professional who provides an objective opinion helps when emotions enter the decision-making process. When markets decline, they can answer questions, provide reassurance, and show you the opportunities that volatile markets may provide.