Fear stock market roller coaster?

Many investors fear the stock market roller coaster. Let’s look at investment “risk tolerance” in a different way, potentially drive out some of the jitters and maybe allow you to seek more growth potential.

Risk tolerance is the degree to which you can handle fluctuations in your investment value. A low(er) risk tolerance means you want conservative, stable accounts. Conversely, high(er) risk tolerance investors are more comfortable with bigger short-term swings in exchange for more long-term growth potential.

Although the word “risk” itself implies danger of true loss — and that’s what people are really afraid of — historically U.S. stock markets are positive about 75% of the time and have always recovered from downturns. Get in, stay in and your money will potentially grow over the long run.

But there are two ways you can lose money:

• One is to own stock in a single company that goes belly-up. That’s true loss, but easy to avoid: Don’t hold more than 5% of your investments in any single company stock. The winners offset losers in a diversified portfolio, so consider sticking with broad mutual funds or ETFs holding hundreds or even thousands of stocks.
• The second is to sell for less than you paid. For example, buy a broad U.S. stock index fund when markets are doing well, then sell during a recession for a lower price per share. That’s true loss.

So why do people sell low? Sometimes it’s an emotional reaction to a market drop: “My account is tanking, so I’m getting out now.” That’s certainly understandable, but again, true loss. Recognize that markets perform in cycles and a downturn is not really a loss unless you sell. Hang on, weather the downturn, enjoy the recovery.

But sometimes people sell securities because they need to raise cash. For example, most retirees regularly liquidate part of their portfolio to pay bills and have fun. That was the plan, right? But this version of selling low can also be avoided, with a simple math exercise to create your “recession reserve.”

How much cash will you need from each investment account during your five-year “recession reserve” period? Stop right now and figure that out. Got it? That’s how much you need to take out of the stock market in each account, right now and put into a more stable holding. Cash would work, but a short-term bond fund will typically at least get a little growth, with historically little volatility. Whatever low-volatility vehicle you choose, this is your “recession reserve.”

During a market downturn, simply pivot to drawing cash from your recession reserve instead of selling stocks. When markets recover, reallocate to create your recession reserve again for next time.

This really works, helping you worry less (or not at all) about market dips. It may allow you to more comfortably participate in the growth potential of the capital markets if you wish — or if your long-term planning shows you really need that extra growth — instead of allocating your portfolio based merely on your age, some other rule of thumb or based on a fear of inevitable market swings.

Work closely with your financial professional to plan your trajectory, choose efficient investments and find balance between what the math says you can do and what your gut says you should do to sleep at night. And reevaluate yearly to make sure your recession reserve is adequate.

This article is written by Kenny Gott from The Kansas City Star and was legally licensed via the Tribune Content Agency through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.