Economic difficulties, political unrest, and natural disasters can all present challenges. Investors may wonder what effect these types of events, and others, could have on their investments. That is why it’s helpful to focus on three fundamental actions that could help investors work toward their goals — know yourself, build a plan, and keep an eye on the long term.
When stocks drop by 20% or more, some investors might ignore the drop, others might feel the urge to sell, while still others might see it as a good time to buy. This range of reactions illustrates different levels of risk tolerance, or how sensitive investors are to market volatility. Risk tolerance varies from one investor to another, and no level of tolerance is considered the “right” level — there’s only the right risk tolerance for each investor. Talking with financial advisors or completing online questionnaires can help investors determine their risk tolerance.
While understanding risk tolerance is essential, it should not be considered in isolation. Risk tolerance, goals, and time horizon all play a role in setting an investment plan.
Investing more aggressively may yield more rewards, but the length of time available for investing also plays a part. A longer time horizon could give investors the potential for compound growth. And setting specific goals can help to determine how much an investor should accumulate to support their goals.
Build a plan
Dwight D. Eisenhower may have said it best — “Plans are worthless, but planning is everything.” Even though a plan may need to be modified to adapt to changes, the very process of setting a plan can help investors to discover and focus on their most important investment goals.
For a plan to be useful, it’s important for investors to clearly detail which goals they are trying to achieve. Some of an investor’s goals will be shorter term, such as building a rainy day fund. Intermediate-term goals might include buying a house or paying for a child’s education. Longer-term goals might include planning for retirement and potentially leaving a legacy for charities or family. Investor assets can then be matched to those various goals.
For example, investors might own short-term bonds to meet a near-term expense, and a mixture of stocks and longer-term bonds to meet needs that are further in the future. The investor’s risk tolerance will help determine the mix of historically more volatile assets — such as stocks — to less volatile assets, such as bonds.
Keep an eye on the long term
Once a plan is in place, it’s important to keep an eye on it over the long term. This includes considering rebalancing the portfolio if allocations move too far away from targets, a task that can be automated. It also includes revisiting plans as an investor’s goals or situation change. A plan is meant to be a living document.
While market drops can be troublesome, unpredictable economic events have presented challenges in the past. With resilience and creativity, America’s businesses and households have managed to overcome them. While there are no guarantees that past performance will repeat itself, history has shown that sticking to investment plans and taking a long-term view of the markets can help investors work toward their goals.
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