If history is a guide, we can expect to experience periods when capital markets suffer serious declines and/or the economy slips into a recession. These can be anxiety-producing developments for investors. Your portfolio may be negatively affected, and you may question whether you need to consider a different financial strategy.
This is one reason why having a well-thought-out financial plan is so important. It’s designed to reflect the financial goals you ultimately want to achieve and guide you through your financial life. It’s also designed to help you stay on track during turbulent times for the economy and markets.
While it’s essential to maintain a proper perspective during these periods, there are steps you can take to help you better prepare for those unsettled times that may occur in the future.
1. Establish or revisit your financial plan
One of the benefits of having a plan in the first place is that it already has some security wrapped into it. As you create or review your plan, here are three specific actions to consider:
- Take a closer look at your financial goals and your time horizon to reach those goals. If they’re no longer realistic, make adjustments so you can stay on track to meet your most important goals.
- Review your monthly budget to assure you’re comfortable with your income and expenditures. You want to be in a position to cover essential expenses at all times.
- If necessary, try to find ways to reduce spending by 3 percent or more so you can set additional dollars aside toward your most important financial goals.
2. Increase your emergency fund
Your emergency cash savings serve as a financial cushion through difficult times or if unexpected expenses occur. The conventional wisdom is that you should have the equivalent of three-to-six months worth of income readily available in savings to tap for immediate needs if they arise. If your income is subject to greater fluctuation in economically challenging periods or just by the nature of the work you do, consider bumping that up to six-to-nine months or longer. It will provide greater financial flexibility to help you cope with challenging periods that may arise from time to time.
3. Re-assess your risk tolerance level
Your investment strategy is derived in large part from the level of risk you’re willing to take. From time to time, you’ll want to reexamine your views on investment risk.
Among the questions that can help you assess your risk tolerance level are:
- Are you willing to accept moderate losses in your investments over a period of time and demonstrate the patience needed to overcome those setbacks? If you are, you could position your investments assuming a high or moderately high-risk tolerance level.
- Do you become uncomfortable and nervous about your portfolio during down markets? If that’s the case, you may want to reduce the amount of risk in your portfolio.
- How old are you and when do you plan to retire? If you’re nearing retirement age (within five years or less), you may want to scale back the amount of risk in your portfolio to avoid any significant losses occurring just before or once you are in retirement. By contrast, if you are in your 20s, 30s, or 40s, time is on your side. You may be in a better position to take on more risk in order to earn a higher return and ride through the market’s challenging periods.
4. Make sure your portfolio is properly diversified
A portfolio positioned to better weather market volatility begins with owning an appropriate mix of investments aligned with your risk tolerance level. Here are factors to consider as you determine the right combination of assets to own:
- Determine the mix of assets you should hold spread among three broad investment categories – stocks, bonds and cash.
- Diversify further within each category through different investment types. For example, with stocks, you may want to include small-, medium and large-cap stocks along with international stocks. You may want to include some combination of growth and value stocks, as well as specific industry sectors in your asset mix. With bonds, you may want to consider government bonds, corporate bonds, and bonds of different maturities.
- Reassess your portfolio at least annually to determine if any adjustments need to be made. As your desired allocations to different assets rise or fall in value due to varied investment performance, you may want to rebalance your portfolio to keep it in alignment with your primary objectives.
5. Get started by talking to your financial professional
It helps to work with an experienced professional who can guide you through the process of developing or updating your financial plan. A plan will help you outline your goals, give you a roadmap to follow to solidify your financial life and help you prepare for periods of market uncertainty. When those times occur, your professional is there to help assess your circumstances and make adjustments as necessary to either protect your financial position or take advantage of new opportunities in the market.
The best time to start is today. Even if you’re currently comfortable with your plan or your investment portfolio, the environment can quickly change. Are you confident that you’re properly positioned for whatever twists and turns may occur in the markets and the broader economy? A review of your current plan or creating a complete plan in the first place can help you gain confidence that you’re on track toward your financial goals.