It’s difficult (if not impossible) to say what stocks will do in the near term. And well-meaning investors who are trying to do the right thing by not being too hands-on with their portfolios (see this market timing article) can end up, inadvertently, with an investment mix that’s too risky, simply because they’ve been letting their winners ride. So, here are five steps to conduct a quick portfolio stress test to see if it’s time to talk with your Azzad advisor about making a change.
1. Check up on your baseline stock/fixed income mix
In strong markets like the bull market that has prevailed since early 2009, most investors tend to leave well enough alone. But if you haven’t reviewed your portfolio’s allocations recently, use the market volatility as an impetus to do so. A hands-off portfolio that was 60% equity/40% fixed income in early 2009, for example, could be more than 80% equity today. And meanwhile you’re older, which means you should likely be in more conservative investments.
Rebalancing is in order in many situations. As discussed here, rebalancing can help align your portfolio’s allocations with your risk tolerance, which is your ability to withstand losses without having to alter your plans. Young investors—meaning anyone under age 50—have high risk capacities in most cases. With many more years on the job, they won’t likely need to tap their investment portfolios any time soon. But investors getting close to retirement will want to put more safe investments in place, to help reduce the possibility of needing to raid their long-term assets while they’re down. Their risk capacities are lower.
2. Assess liquid reserves
In addition to checking your portfolio’s long-term stock/fixed income allocation, it’s also a good time to check up on your allocation to liquid assets (that is, cash): The last thing you want to have to do is raid long-term assets after they’ve dropped because you need to meet near-term living expenses or expenditures like next semester’s college tuition bill.
For retirees, a reasonable option is to hold one to two years’ living expenses in liquid reserves, alongside a long-term portfolio composed of stocks and bonds. For people who are still earning a salary, holding anywhere from three months to one-year worth of living expenses (or even more) in liquid reserves can make for a solid emergency fund. If you have lumpy, ongoing expenses you’ll have to meet within the next year, such as a tuition bill or your property taxes, you’ll want to earmark additional assets for those, apart from your emergency fund.
Opportunistic investors, meanwhile, may want to set aside some liquid assets in case they’d like to deploy cash at a later date, if and when stocks fall. (It’s a reasonable assumption that value-minded buyers will have better buying opportunities at some point in the future than they do today.)
3. Recognize how much is in your hands
Last but not least, the long-running strength of the equity market has inured many investors to the fact that their own actions will have an even bigger impact on whether they meet their financial goals than market returns. But it’s true. Even though the market has contributed generously to investors’ accounts over the past decade, there will invariably be fallow—or worse—periods, and they typically follow the really good ones. In times like those, investors can take comfort in all of the big decisions that are in their hands: their household capital allocations, their savings rates, and their use of tax-sheltered vehicles, among others. Being deliberate about all of those decisions is the best way to take back control, even if the market’s future returns are less compelling than they’ve been in the past.
Note: Diversification does not eliminate the risk of experiencing investment losses.