Monday, November 7, 2011

Get Real About Your Tolerance For Pain

Interesting article in the WSJ this morning on seven pointers to keep portfolios on course. One of the most important bullet points was about getting real about your tolerance for pain:

When stocks are mostly going up, many investors believe they have the fortitude to tolerate a fair amount of risk. But as soon as prices sink, so does their gumption. They realize they really aren't willing to ride the roller coaster down as well as up.

If you didn't learn your lesson before, learn it now: When your current stock exposure makes you queasy, take advantage of rallies to trim it back to a level—perhaps to around a third of your overall holdings—where you won't be tempted to bail out the next time the Dow Jones Industrial Average plummets 400 points.

But remember that you'll need to own some stocks in order to increase your assets enough for the future. Otherwise, once you retire, you'll have to be ultracautious about how much of your savings you can spend without running short of money, says Mark Cortazzo, senior partner of advisory firm Macro Consulting Group in Parsippany, N.J.

If you are going to come up with a static asset allocation and ride it out then this advice makes perfect sense. However, keeping your stock exposure to a third of your portfolio over the long term also means that your portfolio will never really reach its full potential and that will impact what you are able to do for yourself, your family, and society. A better idea is to be tactical. In times like these, when the risk outweighs the rewards, your portfolio should have little, if any, stock exposure. During other times when the market is in an uptrend you can have much more stock exposure.

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