When the stock market drops like it did last quarter, investors get nervous.
This is natural. Who likes to see their hard-earned money lose value? This is also when people make mistakes.
When people get nervous about stock markets, they want to run to conservative investments.
There is nothing wrong with being cautious, but being conservative can bring unanticipated risks.
Many of the terrible markets we have seen in America have eventually recovered. This then means that being conservative is potentially more damaging than being too aggressive.
There are two significant risks with being overly conservative.
The first risk of being too conservative is inflation.
Inflation is the general increase in the cost of goods and services which leads to decreased purchasing power.
Investors who enjoy the safety of CDs and other conservative investments may never see a drop in account value, but they suffer a loss that doesn’t appear on a statement.
Inflation rarely occurs to investors as a risk because is often happens slowly and isn’t very visible.
America hasn’t experienced significant inflation since the 1980s. It is natural to worry about the dangers that are visible and ignore the risks that are unseen.
The second risk of being too conservative is not getting the return needed to meet retirement goals.
Many Americans have a base income provided by social security or pensions. These income streams usually aren’t enough to meet all retirement needs.
To supplement retirement, many Americans use retirement accounts like a 401(k) and IRA. If investors who use these types of retirement accounts are too conservative, they may not achieve the returns they need to meet their goals.
There are several things you can do make sure you stay the correct course when things get tough.
The first is to study market history, particularly bad markets.
It can be comforting to see that most market drops are short-term fluctuations that can actually provide buying opportunities. Investors who run and hide at every market drop will never do well and are not fit to invest.
The second thing investors can do is discover the volatility measures of their portfolio.
There are statistical measures like beta and standard deviation that can help you see how your investments have behaved in previous markets.
Third, you need to have a plan.
When the required rate of return equates to a reasonable amount of risk, investors can stay grounded when the market gets tough.
If you discover in your planning that you need a higher level of risk to meet your goals you may not be ready to retire. Risk can be a good thing, but don’t act foolishly.
Lastly, you should listen to experts.
This means working with an adviser or paying close attention to investment experts with proven track records.
Most people would never think to sail around the world without an experienced captain on board. Don’t put your retirement success in the hand of an amateur even if that amateur is you.