How to protect your assets from market crashes
In my previous article, I showed that average annual return of S&P 500 index was about 5.3% in the last 20 years. However, the stock market did not always produce positive returns.
Every time the stock market crashes, there are those who lose everything. And this can make people hesitant to invest at all. Unfortunately, investing is the only way that most people are going to be able to save for retirement — and, for some, it may just be the way that they build their wealth. There are many ways that you can protect yourself from “losing it all,” it just requires a little forethought and knowledge. All trading is risky, but that doesn’t mean you can’t reduce your risks.
The Importance of Diversification
If you’re investing today, you undoubtedly remember a sequence of huge market crashes: the dot-com bust in 2000, the housing crash in 2006, and the stock market crash in 2008. All of these had something in common: they impacted a single type of investment. The dot-com bubble affected tech stocks, the housing crash affected the real estate market, and the stock market crash in 2008 affected the stock exchange. Those who lost everything were those who were only invested in a single asset class.
By diversifying, investors can mitigate their damages and hedge their bets. Investors should invest in stocks, real estate, bonds, and commodities — as many types of investment as they can. This means that their portfolio will still retain much of its value when a crash occurs, allowing them to recover from their losses.
Asset Allocation and Risk
Different types of asset class may convey different levels of risk. In terms of risk, bonds are considered to be quite safe — as are certain commodities. Real estate has a moderate level of risk — and stocks are at the top as one of the riskiest form of long-term investment (though still not as risky as the foreign exchange market).
It’s always important to diversify, but it is your asset allocation that is going to control how risky your portfolio truly is. By balancing your asset portfolio over time, you can engage in an appropriate amount of risk for your current goals. Those who are just entering the job market tend to engage in higher risk investments because they have more time for their gains (and losses) to even out. Those who are close to retirement may want to reallocate to lower risk investments, as they don’t want to risk a short fall just before they retire.
Determining Your Risk Tolerance
But it isn’t just about stage of life: it’s also about your personal risk tolerance. Before you begin allocating your investments, it’s usually a good idea to take a personality assessment — many financial advisors offer this type of assessment early on. A personality assessment tells you whether you’re a risk taker or whether you’re someone who would rather “play it safe.”
Investing isn’t only about financial gains; it’s also about peace of mind. If you’re the type of person who would worry every time you see the stock market take a plunge, it’s not necessarily a good idea to engage in high risk investments… even if they might make you more money over time. Your quality of life may suffer and you may be tempted to pull out of the market entirely. It is those who pull out of the market when it is at its lowest (rather than allowing it to recover) who tend to lose it all.
Whether you’re nearing your retirement or just getting started, it’s usually a good idea to take a look at the diversification and risk tolerance of your portfolio frequently. Your financial goals may have changed — or you may simply be interested in investing in a different way. Either way, a financial advisor can help.