How to Reduce Investing Risk

Be true to yourself: it works in life and it works in investing. No investments are risk free, but you can reduce your risk by knowing and applying your risk tolerance.

Whenever I am coaching clients or teaching classes on investing, I always start by discussing risk tolerance. Why is it crucial to know how you personally feel about gains and losses in the stock market before you start buying funds or stocks? Because you want to buy investments that you can stick with. If you stretch into a stock that you are uncomfortable with, you may panic sell it when it declines by 25%. If you do this, you have locked in your losses and have also internalized negative reinforcement about the market in general.

When your portfolio is out of balance with your personal definition of safety, you also run the risk of retreating to cash during market dips. You tell yourself you will get back in when the market starts going up again, but how will you recognize it when it’s happening? Even if you miss one day of recovery, your portfolio growth will not catch up. The longer you sit on the sidelines waiting for a sign the worse it gets. 

Here’s a Schwab chart that compares being fully invested for all of 2020, vs missing key recovery days throughout the year.

Source: Schwab Center for Financial Research with data from Morningstar. The year begins on the first trading day in January and ends on the last trading day of December, and daily total returns were used. Returns assume reinvestment of dividends. Fees and expenses would lower returns. When out of the market, cash is not invested. Market returns are represented by the S&P 500 Index, an index of widely traded stocks. Top days are defined as the best performing days of the S&P 500 during 2009. This chart represents a hypothetical investment and is for illustrative purposes only. Past performance is no indication of future results.

Multiply this by 5 years, 10 years, etc and you can see why the old adage is true: “time in the market is better than timing the market”.

So, what’s the alternative to all of this? 

1) Do an assessment of your personal risk tolerance (you can download an easy Risk Quiz from Schwab here).

2) Make sure you are diversified through buying a balanced portfolio of investments across a range of asset categories based on your risk tolerance.

3) Review performance and make small rebalance adjustments once or twice a year.

4) Ignore the noise.

Most of us are saving and investing for retirement that is decades away. Reacting to a one week dip is not necessary if you are focused on your long-term goals. Know yourself, be true to your own path and invest for your future. That’s smart, Sister!

Bridget Jones founded Smart Sister Finance on the truth that money confidence unlocks life choices. Smart Sister Finance offers customized one-on-one coaching and online group events to ensure that every precious, hard-earned dollar has a purpose and is used to the best advantage in life. Join the community of smart sisters @SmartSisterFinance.