Rainy days such as these are important reminders that what goes up can also come crashing down. The recent hacks and slashes in stock prices stress the importance of good financial planning, especially when it comes to retirement funds or a household’s nest egg.
Self directed IRAs (or Individual Retirement Accounts) offer great opportunities but also great risks. Managing your retirement portfolio by yourself enables flexibility, reduced commissions and completely matching your portfolio to your needs and estimations. However, professional portfolio managers exist for a reason. It is quite difficult to be emotionally detached from your own equity and decision making. Furthermore, acting unprofessionally can cost you very heavily.
How can we avoid suffering a heavy loss to our retirement funds?
#1 Monitor your asset allocation on a regular basis
Asset allocation is critical. A right mix of financial assets can make the difference. You should constantly be aware and monitor the following in your portfolio:
a. The mix of stocks and fixed income – Your primary risk generator is probably the share of stock you own. As value increases so does the share stocks take in your portfolio. Fixed income assets are crucial to balance risk levels and lower total portfolio risk.
b. Exposure to sectors and investment terms – Naturally stocks and fixed income assets should also be diversified to sectors and terms of investment. Again, as sectors evolve we might find ourselves with a strong financial sector bias which could prove to be costly should the sector crash and burn (hypothetically speaking).
c. Exposure to foreign currency – As most of us earn and spend in dollars our investments should be made in dollars as well. However, as currencies fluctuate and sometimes suffer periods of relative weakness it is important to have a small share of exposure to foreign currency in our portfolio. We should pay careful attention to the fact foreign stocks and ETFs are also considered investment in foreign currency (as their dollar value is also influenced by the exchange rate) and be careful not to increase our exposure without intention.
d. Geographical diversification – As globalization evolves we see a growing global flow of funds and accordingly a growing share of investment in other geographies. However, we are still home biased. I think keeping a home bias in a portfolio is still correct but we should also gradually increase our exposure to foreign markets. As the world evolves so should our portfolio.
#2 Adjust your portfolio to your age and risk preferences
Saving for retirement is usually long term. But your investment term obviously changes with your age. There is a debate in academic papers whether life cycle investing, or adjusting the risk to your age, is correct academically (the popular claim is that long term investment in stocks is still dangerous even though the deviations are evened out or otherwise there wouldn’t be any premium on long term investment) . While that is an interesting debate financial planners practice life cycle investing and usually swear by it. It is also intuitively appealing. A 60 year old person should by no means invest 50% of his portfolio in stocks as his retirement in on the line. A 20 year old still has the time to correct market crashes and can take short term (even 10 years) loss.
Be aware of your portfolio’s risk and adjust it to your age and risk preferences. If you are not sure about how much you dislike risk or what should your portfolio be made of I strongly suggest turning to a financial planner for help.
#3 Don’t be tempted to time the market and avoid trying to spot what may appear to be short-term investment opportunities
Its times like these that make your fingers itch. Such a drop in values will surely be followed by a strong bullish period since the weak companies are weeded out and the strong remain… etc… Why shouldn’t I increase the share of stocks in my portfolio?
Don’t be so sure. This slowdown and financial crisis might turn out to be caused by a fundamental economic change (for the sake of the example) and you just might never see your investment again. If you need an example just take a look at the Nasdaq at 2000’s and the Nikkei since 1990’s. Both have yet to regain their losses. Do you have the luxury of waiting 20 years for a decent return on investment?
Investing is all about discipline. You may and probably should take more risks with access savings. However, your retirement funds should not be experimented upon. I, personally, recommend turning to a financial planner who can apply the correct analytics tools and models and make sure your money for old age is safe and secure.
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4 comments:
Great post. I think it's also important to remember at a time like this to buy as much as you can since it's "on sale". That's how I feel about it... I hope the market stays down for a while so I can continue to buy more.
Ahhh, the best advice is always the simplest. Sadly, I don't forsee the average investor following it anytime soon.
While the post focused on investment strategies, I would add "Do not take early distributions," to the list of crippling factors.
Here via CoPF.
Good advice! Thanks!
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