Feeling fearful when markets turn? Time for a risk reality check
Depending on your age and investing experience, the market downturn in March caused by the COVID-19 crisis may have been a real shock or just the latest in a series of unfortunate events in your investing life. Either way, these types of market gyrations bring to the fore our personal relationship with risk.
While we may understand risk as a concept, especially easy to do when the markets are up, it takes a serious downturn to face our emotional reactions to risk. If you’ve been feeling anxious, it may be time to re-evaluate your tolerance for risk.
The risk/return relationship
Every type of investment carries some kind of risk. Even if you choose not to invest, you experience what we call opportunity risk – because you could have made more money by investing than by staying on the sidelines.
Lower-risk or guaranteed investments such as Guaranteed Investment Certificates (GICs), may protect capital, but you trade off any chance of significant potential for growth. Over time, this could mean falling short of your goals. To compensate, you may need to save more, spend less, generate more income, or delay the achievement of your objective (for example, retiring at 65 instead of 60).
Investments like equities can offer greater returns, but these come with higher-risk profiles. Keep in mind there is a wide variety of equities to consider across a broad risk spectrum. Quality, blue-chip companies with a history of price growth that pay dividends and have good prospects will fall lower on the spectrum. Conversely, stocks in companies that have newer products, operate in more volatile markets, or are denominated in foreign currencies all carry greater – and different kinds of – risks. These have the potential for very high rates of returns, but you need to assess whether these are appropriate for your portfolio given your objectives.
Remember, too, that risks can be managed. For example, holding a portfolio of diversified investments helps to reduce the impact of a temporary downturn in any one investment category.
It’s human nature to overestimate our ability to handle risk when times are good – and to be exceedingly fearful after a big loss. That’s why it’s essential to focus on your portfolio as a whole and keep your investing goals and time horizon in mind.
At the end of the day, your portfolio should take enough risk to help generate the returns needed to meet your long-term objectives – but not so much as to make you uncomfortable. If you’re ever feeling uneasy, let’s talk.