I have a question for you. Let’s say March 23, 2020 ends up being the bottom of the current, coronavirus-inspired bear market. On a scale of 1–10, how badly did it frighten you? Assume “1” means, “Bear market? What bear market?” and “10” means, “OMG; I sold everything and went to cash!”
For the sake of discussion, let’s assume you were thoughtful when you selected your investments. You recognized that higher allocation to stocks equals additional decline when markets don’t behave. You also considered whether you had the fortitude, or risk tolerance, to ride out declines without too much difficulty.
Now, along comes a real bear market, bringing out your worst fears. How accurately did you estimate your ability to stay invested according to plan? Assess your risk tolerance now – before markets recover, and your mind plays tricks on you about how well or poorly you actually tolerated the downturn. (This is called hindsight bias.)
Why does understanding your real risk tolerance matter? Because, you’ll have to revisit these same fears in a future bear market. Knowing how you reacted this time helps you decide whether you should permanently shift toward or away from the stock market risks you’ve been taking on so far.
Just remember: Bear markets aren’t the only risks around. There’s also the risk that you won’t accumulate enough wealth to reach your retirement or other key goals. And whenever you move away from stock market risks, you’re also moving toward lower expected returns over the long run and, therefore, away from your accumulation goal.
So, was your March 2020 fear factor approaching “10”? If so, your risk tolerance probably wasn’t what you thought it was. If you can afford to, you might want to scale down your market risk exposure for next time.
On the other hand, if you need those future expected returns if you ever hope to retire, I would suggest additional financial education on how capital markets work over time. This should help you stick to your plan more effectively in the next bear market. A little education can help you become a better investor, if still not an entirely fearless one.
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