Professional investors constantly think about short-term threats to their portfolios, assessing not only each investment they hold, but also how macroeconomic factors, such as growth in global economies and policies set by central banks, could affect returns. That's because when things do head south, the pros must act — or at least explain to their clients why they didn't.
In this regard, the average long-term investor enjoys an advantage over the pros, says Rich Bookstaber, founder of Fabric RQ, a risk-assessment platform for financial advisors.
"As a long-term investor, you're armed to say, 'Fine, if things do go down, I can sit through it,' instead of panicking that the world will end. Banks and hedge funds can't do that," he says. "Young people have a huge edge over high-powered investors, because if something happens [to the latter], their clients aren't going to listen when they say things are going to work out."
If you're still decades away from retirement, investing experts say you're mostly free to ignore potential short-term hiccups in the market. But longer-term risks deserve your attention, they say. And acting now to mitigate them could boost your returns over time. Here's how to think about risk in your portfolio.
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If you're investing in the stock market over the course of decades, you can be relatively confident in two things: Stocks will increase in value, and there will be bumps along the way. The timing of those setbacks is out of your control, and doesn't need to be the focus of your attention, says Bob Schneider, a certified financial planner and wealth advisor at Johnson Financial Group in Milwaukee, Wisconsin.
"You can't control the behavior of other investors. You can't control the political environment. You can't control the news. All of these things have an impact on markets," he says. "Short-term fluctuations aren't things to be concerned about. What you need to focus on are the things that you can control."
Chief among those, he says, is the frequency at which you invest. "If you have a workplace retirement plan or a Roth IRA, you should be systematically investing your excess cash flow," he says. "Whatever the frequency, get started early and don't interrupt it."
You also need to be aware of how you'll react in a market downturn. "One of the things we can control is our emotions," says Karen Wallace, director of investor education at Morningstar. "Sometimes the biggest risk we face is selling our investments at the wrong time."
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Selling your investments when markets slide, instead of hanging on until stocks bounce back, can significantly hurt your portfolio. If you think you're prone to panic-selling in response to a big loss in your portfolio, examine your holdings to make sure you're properly diversified. Risk-averse investors may want to hold a higher allocation to bonds, which tend to lose less than stocks in down markets. Within your stock portfolio, make sure you have a good mix of companies of different sizes that operate in different parts of the world.
Investing in a few low-cost, diversified ETFs can help ensure that mix. But make sure you're not invested in too many funds that have the same companies among their top holdings, says Schneider. "There may be overlap in some of the ETFs you hold," he explains. "We don't like to see more than 5% of a portfolio in any one stock," as that can expose you to more risk if it crashes.
Though it's smart to mostly ignore short-term risks to your investments, you'd be wise to act early to hedge against long-term threats to your returns, says Bookstaber.
"There are some risks that matter a lot that have a longer time horizon," he says. "Climate change is a big one. Changes to the demographic picture. The impact of artificial intelligence. The shift to clean energy from fossil fuel. You have to envision what the market is going to look like 30 years from now."
You may be tempted to cross some of those bridges when you come to them, but by then, a forward-looking market may have left some of your holdings by the wayside, he says. "If you think there won't be gas stations in 30 years, you may think, 'Fine, I'll get to that 15 years from now,'" he says. "But the thing about investing is it's not the event. It's the anticipation of the event. And the effect may happen sooner than you think."
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To address long-term risks, Bookstaber recommends holding the vast majority of your investments in a diversified core portfolio. "Then you adjust around the edges," he says. "If I think fossil fuels are going to be gone by the time I get older, maybe I pare back my ETFs that hold them." You could also invest in thematic ETFs, which aim to benefit from trends that could pose a threat to some of your holdings.
"You're just trying to skirt around some of these risks — you don't have to be super-aggressive," Bookstaber says. "But why not reduce risk in your portfolio and incrementally improve your return?"
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