As discussed in the last post, dealing with all the emotions involved with the recent market rollercoaster can be incredibly difficult. As volatility calms somewhat and talk of whether the market has turned the corner takes focus, our stomachs settle a little and reflection begins on how to avoid this the “next time”.
There are many so called experts suggesting that everyone revise their asset allocation, revamp how you look at potential returns over the long term, and distrust any kind of planning technique that did not 100% forecast the recent downturn.
While I would never suggest that thoughtful reflection on your finances is a bad thing and that thinking through what really is a need versus a want and how that relates to your tolerance for risk is certainly a worthwhile exercise, I would caution against sweeping changes to your investment philosophy based solely on the events of the last several months.
If you’re a long term investor, your recent investment experience has no doubt been as painful as most. That said, as prices have been driven down, long term expected returns have increased substantially. In other words, you are seeing an increase in expected reward for your perceived increase in risk. Taking the view that market gains will never return or that we are bound to head into historic downturns more frequently in the future is not so much a flight to conservative thinking as it is unnecessary fear due to recency bias. It is this same bias that helped precipitate the downturn in the first place as, back in 2007, the popular opinion was that the good times would never end.
Allowing your emotions to swing the risk pendulum back too far in the direction of safety will serve only to compound the issues you already face. In fact, it is the decisions you make now that will effect your long term success as an investor, not the decisions you’ve made over the last several months. Paying attention to your spending and staying true to your goals, investment strategy, risk tolerance and retirement needs is what will really pay off in the long run.
By Chip Workman