I’m seeing more people come to me with portfolios that take on even more risk than I saw back in 2007, in the year before the stock market collapse. By investment risk, I’m referring to portfolio allocations with a greater percentage in stocks or stock funds and a lower percentage in high-quality bonds or bond funds.
I tell these people that they may be overestimating their willingness to take risk or that they don’t have a need to take on such high amounts of risk.
Here’s why this trend seems to have circled back, and what you should consider before it’s too late.
1. We have short memories.
The current bull stock market is nearly 8½ years old, making it the second-longest bull market in history. Memories of the intense pain we experienced in 2008 and early 2009 have long faded, and we’re feeling bulletproof again. Though we may think we have a high risk tolerance, studies reveal that the way we feel about risk is not stable. The tendency to lower our risk tolerance after a plunge leads to the very human behavior of buying high and selling low. So rather than rebalance a portfolio and sell stocks after the surge, inertia takes over and we let the gains ride until it’s too late.
2. High-quality bonds pay very little.
In 2007, a 10-year Treasury bond was paying as high as 5.26 percent. As of Aug. 23, it pays only 2.26 percent. So back in 2007, we at least had an alternative for safe income — but today, not so much. This leads us to make two mistakes. First, we move more heavily into stocks. I’m hearing the argument now that “safe dividend stocks” are a bond alternative. In 2007, those so-called safe dividend stocks were financial companies that got creamed. Second, we try to juice up our income by buying “high-yield” bonds or funds. Another name for “high-yield” is “junk,” and that’s appropriate. In 2008, the average junk bond fund lost 26.43 percent and failed to act as a shock absorber like high-quality bond funds. In 2008, a high-quality bond fund like the Vanguard Total Bond Fund ETF (BND) gained over 5 percent and provided safety when it was most needed.
3. You may not have a need to take much risk.
Risk profile questionnaires don’t measure our need to take risk. There comes a time when it may be possible to take some risk off the table and reduce exposure to stocks and lower-quality bonds. As I tell clients, dying the richest person in the graveyard isn’t the right goal. Or as financial theorist and author William Bernstein puts it, “when you’ve won the game, stop playing.” That means you may be able to take some risk off the table and lower exposure to stocks and low-quality bonds.
My advice: Remember the pain
Try to find some of your investment statements from late 2008 and early 2009. Do anything you can to remember the pain of the last bear market. If your response to that pain was to sell, reflect on whether you can withstand the same pain the next time it happens. Because it will happen again — it’s just that no one knows when or what the cause will be.
Consider lowering your exposure to stocks. Any risk you take, however, should be with stocks, and your bonds should be boring and act as your portfolio’s stabilizer the next time stocks plunge.
Remember two things: Bull markets don’t last forever, and the primary purpose of your portfolio is to allow you to live a more enjoyable life. Your willingness and need to take risk may not be as high as you think.
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