Recent stock market volatility may have you rethinking your portfolio. Ensure you understand risk tolerance and if your portfolio is suited to your goals.
It has not been a great few weeks in the stock market with the Nasdaq now in correction territory and the S&P 500 in close pursuit. Fears of geopolitical issues between Russia and Ukraine, higher rate concerns and inflation have seen investors unwind positions - mainly in tech dominant names.
As with any sell-off, it's natural to pay closer attention to what's going on in the market and wanting to intervene in your own portfolio. Many investors may consider selling out of their positions to reduce any potential further loss.
If you find yourself in this camp it is prudent to consider two things:
Risk tolerance can often be an overlooked factor for many new investors. Historically, a financial advisor would sit you down, have you answer some questions and assign you to a mutual fund who's asset allocation aligns with your goals and risk tolerance as they see it.
However, with bonds at historical lows, many have avoided this mix and instead are heavily concentrated into stocks.
Generally speaking, the longer your investment horizon, the younger you are and the more disposable income you have, the more risk you can bear. As you age or as you get closer to requiring that capital, your risk tolerance may drop and thus your portfolio should adjust.
With this current stock market rout, if you find your portfolio losses are bothersome, you may want to reconsider how you are positioned and if you need to rethink your risk tolerance.
Within Investipal, once you've submitted your questionnaire, you can head over to the investment profile section to gain a sense on your risk tolerance.
Once you have identified your risk tolerance, you now have to consider how to relate your investment portfolio back to it. This entails considering your:
Asset mix plays an important part of your risk tolerance. Generally, bonds are less volatile than stocks and perform better when the stock market sells off. However, with the current interest rate environment, bonds may not make the most sense for your portfolio. Instead you can look to alternative asset classes or stable equity vehicles like low vol or covered call ETFs.
Low volatility ETFs take two approaches: either they select stocks that exhibit low volatility or they build a minimum volatility portfolio. In essence, they aim to accomplish the same goal, reduce your volatility.
Covered call ETFs are typically high yield products that write call options against their portfolio holdings. When the market sells off, the call writing feature helps provide some downside protection.
By adjusting the weighting of your portfolio holdings, you can help minimize the effects a few higher volatile names have in your portfolio. A risk averse investor may want to consider boosting weights for securities that offer more stability and reduce ones which experience high standard deviations or high beta.
Asset correlation is often times the most overlooked consideration by investors. By investing in similar behaving stocks/ETFs, you compound risk as these securities trade the same way (e.g., they will both go up or down together). By analyzing your asset correlation, and reducing or eliminating highly correlated assets, you will reduce this compound risk effect.
Taking it a step further, by selecting negatively correlated assets, you end up building a robust portfolio that minimizes overall risk. This is the approach min vol ETFs operate under.
In the example below, HGRO and IQD see a 0.66 correlation - quite high, while XSEA is negatively correlated with both HGRO and IQD. If either were to sell off, XSEA may end up generating positive returns and counteract the other two's performance.
Stock market volatility is nothing new and will always be a part of investing. How you handle this volatility depends on your risk tolerance and ability to withstand some pain. Remember that time in the market trumps timing the market.
If you find losses within your portfolio are taking a mental toll, you may want to consider how you have built your portfolio and if it's in-line with your risk tolerance.
Investipal is a platform to build and manage your ETF portfolios, tailored to your individual goals and risk tolerance. If you need to reconsider your investments or want to get smarter on how your ETF portfolio is built - check us out for free!
Our goal is to empower DIY investors with the tools you need to make informed investment decisions. Please share us with your friends or family if you think they would be interested.
Praesent vitae ultrices tellus, vel porta felis. Suspendisse sit amet fermentum urna pulvinar erat. Vivamus nec quam ac enim placerat mollis.
Factor investing is a strategy that chooses securities based on attributes that are associated with higher returns. These attributes, or 'factors', have been historically proven to outperform the broader market over time.
You've likely heard of total stock market funds But do you really know what they are, how they work, and more importantly, if they're the right fit for your portfolio? Let's dive in and find out!