Many investors who have watched their account values consistently rise over the last decade are very happy with their investments. However, during times of low volatility and steady gains, investors may tend to under estimate the risk of their portfolios and overestimate their own investment prowess. Eventually, the stock market will have a bad year and equity investors will lose money.
That may be when investors start reevaluating the risk level they are comfortable with. Even if you own a portfolio filled with high quality stocks, you are not immune from market corrections. After all the S&P 500, which consists only of “Blue Chip” stocks, went down more than 50 percent during the market crash of 2008. Therefore, it’s entirely fair to assume your stocks could lose 50 percent of their value the next time we suffer a major correction. If you are truly a long term investor, a large draw-down isn’t the end of the world, as stocks have always rebounded if held long enough.
According to a prominent study by Dalbar, the problem is that most investors under-perform the market because — among other things — they make poor market-timing decisions. When investors see the value of their accounts diminishing quickly, they tend to get more conservative and reduce exposure to stocks. This causes them to miss the eventual rebound.
One of the ways to be a more successful investor is to reduce the potential downside in your portfolio to a level that you can tolerate. First, you need to truly understand and quantify your risk tolerance. You can take two minutes to understand your risk tolerance by going to www.findoutmyrisk.com. Once you know your risk tolerance number, you can adjust your portfolio to make sure it does not have a risk exposure that is higher than you can tolerate.
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