Investors bruised by recent punishing losses in stocks have something to look forward to: corporate earnings.
The benchmark S&P 500 index has risen in seven of the past nine earnings seasons, climbing on average 1.7% during the four weeks after big banks kick off the reporting period, according to Dow Jones Market Data.
Even more encouraging is that in three of those periods, the S&P 500 had fallen in the four weeks leading up to earnings season. In other words, it isn’t unusual for the equity market to go through a period of weakness before corporations report earnings.
That is one reason some analysts remain confident that solid company results can power the stock market higher after last week’s 4.1% drop. Wall Street analysts estimate S&P 500 profits rose by 21% in the third quarter from a year earlier, according to a
Some analysts have said a higher level of stock buybacks could also underpin the market. Share repurchases by many companies slowed in the month leading up to earnings. Companies in the health-care and technology sectors—the market’s leaders this year—are particularly poised to benefit from buybacks,
The performance of individual stocks also tends to be more dispersed on days with more earnings reports, the Bank of America analysts found. That potentially increases opportunities for stock-picking investors.
Although stocks have tended to climb during earnings seasons recently, there have been exceptions. During the busiest part of the reporting season in January and February, the S&P 500 fell 6%, marking the first rout for the equity market in months.
Some investors still warn that the market could also suffer this time around if company executives give cautious outlooks on earnings calls or if comments about the U.S.-China trade dispute lead to more volatility.
To receive our Markets newsletter every morning in your inbox, click here.
Before last week’s selloff, a reasonable expectation was for a stable market headed into the earnings season that started last Friday. Instead, even before the first major reports came in, stocks plummeted. When such an unexpected event occurs, there are the immediate questions, “Why?” and “What next?” Of special interest is whether the market is finding a new, lower “normal,” or is simply shaking out weaker holders while setting the stage for a new rise. Below are the analytical steps I find helpful.
Disclosure: Author holds U.S. stocks and U.S. stock funds
First, list the potential reasons that are being discussed
In today’s market the focus primarily has been on these possible causes:
Technology companies/stocks coming under pressure
Global trade worries, including tariff effects and China slowdown
Rising interest rates’ negative impacts
Second, identify whether the issues are new or have increased in importance
Technology:Nothing new or increased. The issues of popularity (previous good performance), possible government regulations and the prior week’s declines were all known and discussed.
Global trade: Nothing new or increased. In fact, the uncertainties surrounding tariffs and China have produced volatility for much of 2018.
Rising interest rates: Nothing new or increased. Moreover, this is an area where one-sided, simplistic reasoning is currently ignoring the benefits and incentives created by rates rising – also, that rise is mislabeled as “tight money;” it is simply a return to “normal,” market-determined levels.
Third, if there is no new or increasing negative that is a viable cause of the selloff, is there a reasonable alternative?
This question always raises the issue of insider knowledge: What if “they” are selling because “they” know something that we do not. It certainly can happen with an individual stock, but very rarely with an industry or sector, much less the entire stock market. Therefore, it is best to dismiss this possibility as far-fetched until something is actually revealed.
New discussion: Cold war?
The only “revealed” item that I can identify comes from The Wall Street Journal’s article: “U.S. Edges Toward New Cold-War Era With China.” That scary sounding headline seemingly takes the tariff “war” uncertainty to a new, frightening level. The opening paragraph even implies the White House is considering serious, intense, even physical, tactics:
The Trump administration is moving deliberately to counter what the White House views as years of unbridled Chinese aggression, taking aim at military, political and economic targets in Beijing and signaling a new and potentially much colder era in U.S.-China relations.
However, the article is a collection of what we already know, but the reporters have amped up the negativity and even included some war terminology. Ignored is the other way to view the Trump administration’s new hardline messaging: Frustration from expectations unfulfilled.
“Where this ends is a trade deal,” a senior administration official said. “Xi is starting to look at this and say, ‘Wow, Trump is doing the things he said he’s going to do,’ and realize that he has to get to work.’”
Instead, Xi appears to be fully in control regarding China’s responses to the U.S. tariff actions. Moreover, in spite of the tariffs, President Trump’s key yardstick, the U.S. trade deficit with China, is growing, not shrinking. Hence, frustration.
That leaves bearish feelings as the most plausible source of the stock market selloff
This year’s lengthy stock market meanderings following the sharp, tariff-related drops produced a widespread sense of bearishness. Then, with the recent, steady climb to new highs, that bearishness actually seemed to increase, even accompanied by dire forecasts.
The reasons are numerous, but all suffer from the same two flaws: overly simplistic reasoning (like rising interest rates killing growth) and overly discussed propositions (think about how long we have been hearing the market is overpriced). Additionally, sharp drops require new and unexpected facts; fundamentals that truly adjust valuations downward. Emotionally driven selloffs are, by their nature, unsupported, so can reverse as soon as emotions settle down.
Fourth, explain how the likely alternative might play out
With the third quarter earnings reporting right around the corner, we are about to get new facts: How each company fared this summer and, especially, management’s view of what’s happening in the fourth quarter and what the outlook is for 2019.
With those facts and outlooks, analysts and portfolio managers will drive the discussion of whether a company’s stock is attractively priced or not. Could there be negative surprises from the company reports? Of course. Moreover, if there is a general tone of somewhat lower growth and/or uncertainty, it could adversely affect the overall stock market. Importantly, whatever the results, we can expect reality, not emotions, to be the driver.
The bottom line – what to do now
Watching the bottom drop out of the stock market is unnerving, leaving many investors worried. The best approach is to step back and try to determine the real reasons for the decline, including how those conditions might change.
The analytical process discussed above helps answer the question of what should be done in response to this stock market selloff:
Do not sell – There are no new, significantly negative issues for altering the reasons for owning U.S. stocks
Do not be surprised if the selloff takes a bit of time to end– This is no fun, but when emotions run strong, so can a short-term trend.
Watch for special stocks – The selloff has been broad, taking down even promising opportunities.
Stay calm and let time play out – In the end, it is the only way to know whether this selloff is an adjustment to a new, lower “normal,” or is another unnerving “shakeout” that becomes obvious after the fact.
Last week was a rocky one for the stock market. In a single day, the Dow dropped 832 points, which constituted one of the most substantial declines in its history. The S&P 500 and Nasdaq also took a beating, so much so that if you checked your portfolio at any point last week, there’s a good chance your first inclination was to sell before things got worse.
But hopefully you didn’t sell. Hopefully you did the smart thing by sitting back and waiting to let things play out. And if you didn’t, let this be a lesson: Volatility is a cornerstone of the stock market, and it isn’t actually something to be afraid of.
IMAGE SOURCE: GETTY IMAGES.
The worst way to deal with a stock market decline
One thing you must remember about stock market volatility is that you don’t actually lose money until you react to it. That gasp-worthy loss you might’ve seen on your computer screen last week when you checked your portfolio balance? Unless you sold anything, it was only hypothetical.
Stock market fluctuations — even sizable ones — are completely normal and even somewhat predictable. And last week’s downturn, if we even want to call it that, was by no means catastrophic. In fact, the Dow, S&P, and Nasdaq are still very much up since the start of the year despite the dips they just took.
If you let yourself panic every time the market falls by a few percentage points or even undergoes a full-fledged correction (a decline of 10% or more), you’re going to harm your health and possibly your finances if said panic leads you to make rash decisions. Not only are corrections fairly common — they happen, on average, about once a year — but the market has historically recovered from them and then some.
In fact, the only real way to get hurt by a market dip or correction is to take a short-sighted approach to investing. If your goal is to put some money into stocks and get out quickly, then yes, a decline could spell serious trouble. But if you have a longer investment horizon — say, 10 years or longer — you’re more likely than not to come out ahead, provided you leave your portfolio alone when the market does tumble.
Of course, this doesn’t mean you have to sit back, do nothing, and let those market dips play out. While it’s generally not a good idea to sell off investments during a downturn, one thing you can do is try to capitalize by buying the right stocks on the cheap. But make no mistake about it: The best way to make money through stock investing is to put money into strong companies and hold those positions for the long haul. Loading up index funds is another good option, since these funds move with the broader market and offer instant diversification.
One final thing: Make sure to have a healthy supply of emergency cash in the bank at all times. The last thing you want is for an unplanned bill to land in your lap during a market dip, thereby forcing you to sell investments during a week like this past one.
The new mantra for investors this week may be good things come to those who wait.
Wall Street pundits on Monday continued to urge caution, predicting that the stock market turbulence is far from over. Yet many of them ended their commentary on an optimistic note, suggesting that the bullish backdrop for stocks remains intact.
Stephen Suttmeier, a technical research analyst at Bank of America Merrill Lynch, said there are plenty of oversold stocks and bearish sentiment is on the rise but the market has not quite deteriorated to a point where the negative trend turns into a contrarian indicator to buy.
“More time and downside tests may be needed for a firm market low,” said Suttmeier in a note to clients.
One technical indicator the analyst is watching is the CBOE 3-month Volatility Index/CBOE Volatility Index
ratio which closed at 0.863 on Oct. 11, the “most fearful oversold” since it dipped to 0.758 on Feb. 5.
“Spikes below 1.0 on the VXV/VIX have suggested tactical capitulation and have coincided with important lows on the S&P 500, but these lows sometimes get retested,” he said.
About 46% of S&P 500 stocks are above their 200-day moving averages, the lowest since early 2016, while 12% of stocks were hitting 52-week lows as of last week.
“This deterioration is seen across all the major U.S. equity averages and suggests a weakening or later stage bull trend from early 2016,” he said.
For now, the S&P 500 is trading above its 12-month moving average while its monthly moving average convergence divergence (MACD) — a momentum indicator that illustrates the relationship between two moving averages of prices, remains a buy signal. But if the S&P 500 12-month moving average falls below 2,747 and the monthly MACD switches to a sell signal, the risk for a bear market will rise, according to Suttmeier.
Another metric to keep an eye on is the high-yield option adjusted spread—the premium that investors demand in return for owning riskier debt over investment grade.
“The big level to watch on the high yield OAS is 3.68-3.72 (2018 peaks). A break above this level would point to increasing credit market stress and likely confirm a failed breakout in the S&P 500 ahead of a bigger equity market pullback,” the analyst said.
The high-yield OAS traded at 3.44 last week.
Key support ranges to monitor for the S&P 500, levels where investors feel comfortable about buying back into the market, are 2,729 to 2,710 and then 2,692 to 2,676.
But as bad as things look, there are reasons to be upbeat.
“Many people focus on ‘sell in May and go away’ but the better and much less well known pattern for the market is ‘buy in October and stay’,” said Suttmeier, who pointed out that November to April is a good time for stocks.
Going back to 1928, this six-month period has been up 71% of the time for an average return of 5.07%. This time, it could be even more bullish given the traditional boost from a midterm election year, he added.
Tony Dwyer, chief market strategist at Canaccord Genuity, likewise predicted that it could take some time for the pullback to resolve itself.
“We find it unlikely there will be a V bottom given the sharpness and breadth of the correction,” he wrote in a Monday note.
In fact, he went as far as to hint that the market’s rally to 3,200, which he had predicted by the end of the year, could be delayed into 2019 depending on how long it takes for the market to bottom. However, he stopped short of revising his outlook and reiterated his view that the current period of weakness is likely to be temporary.
“It is essential to remember that while any number of fundamental excuses could be used, this correction was born out of 1) excessive optimism; 2) an extreme intermediate-term overbought condition; and 3) historically low volatility – rather than a significant enough fundamental change that would suggest a shutdown of credit, and ultimately negative EPS,” he said.
Here is Dwyer’s checklist of tactical indicators to watch:
Meanwhile, David Kostin, chief U.S. equity strategist at Goldman Sachs, reminded investors that 5% drawdowns are fairly common.
“Since 1928, the index has typically suffered a 5% pullback once every 71 trading days. 69 trading days elapsed between 5% drawdowns prior to Thursday,” he said.
The good news, though, is that Goldman strategists do not see much significant upside to bond yields and expect the 10-year Treasury yield
to close out the year at 3.1% compared with 3.161% currently.
Kostin stuck with his year-end S&P 500 target of 2,850, noting that the probability of a recession in the next three years is roughly 37%.
“The year to date surge in EPS combined with a modest climb in S&P 500 has reduced forward P/E multiples by 14% to 15.7 times, reducing valuation risk for equity investors,” he said.
One indicator that Kostin finds encouraging is the strong return on equity, a popular gauge for corporate profitability, which rose to 17.5% in the second quarter, among the highest in the past 40 years. Excluding financials, ROE hit a record of 20.7%.
Still, the strategist expects companies to feel some margin pressure given higher interest rates and recommended investors to focus on corporations with strong balance sheets such as TripAdvisor Inc.
The heaviest selling of the week was on Wednesday and Thursday, when the Dow plummeted nearly 1,400 points, or more than 5.2 percent, in the two sessions.
Despite a strong rebound on Friday, the Dow and S&P 500 fell more than 4 percent for the week. The Nasdaq dropped nearly 3.75 percent for the week.
“What they’re doing this week is like a man in a dark room. Just reaching out to find out which way it can walk and not stumble,” Cashin, director of UBS’ floor operations at the New York Stock Exchange, said on “Squawk on the Street.”
Last week’s decline was fueled by concern the Federal Reserve might raise rates more than forecast. The central bank has already hiked rates three times this year, and one more is expected in December.
Stocks were slightly in the red at midday Monday, with tech stocks like Apple and Netflix bringing the Nasdaq lower. Cashin expects the technology sector to continue to be an underperformer.
He also said “a lot wild cards” could impact the market this week.
CEOs pulling out next week’s Saudi investment conference could have an impact on stocks, Cashin said, but as of right now there are minimal signs in the financial or oil markets.
U.S.-China trade tensions also remain a concern, Cashin said. Most recently, the U.S. levied duties on $200 billion worth of goods from China, prompting Beijing to put tariffs on $60 billion worth of U.S. goods.
Cashin began his career in 1959 at Thomson McKinnon. In 1964, at age 23, he became a member of the NYSE and a partner in P.R. Herzig & Co.
Maybe investors should be getting more accustomed to stock-market plunges akin to those that rippled though markets last week, knocking more than 830 points off the Dow Jones Industrial Average on Wednesday and leaving the blue-chip gauge and the S&P 500 with their worst declines since February.
They might also take comfort from history, which also indicates that when they occur, a market bottom usually isn’t too far away.
“If sudden market plunges out of nowhere seem to be happening more frequently than in the past, it’s not just you,” wrote Pravit Chintawongvanich, equity derivatives strategist at Wells Fargo Securities, in a Monday research note.
Such sudden bursts of volatility have become more frequent in the past few years, he said, pointing to the chart below.
The graphic looks at days when the ratio of 5-day to 3-month realized volatility exceeded 3. “In other words, days when there is a huge burst of volatility compared with what’s been the norm,” Chintawongvanich wrote. Since 2007, there have been six such events versus only five in the preceding 50 years. In fact, a 22-year stretch from 1964 to 1986 didn’t see a single one, he noted.
fall 3.3%, while the Dow dropped 831.83 points, or 3.2% — the biggest one-day drops for each since Feb. 8.
The striking thing about almost all these events, he noted, is that market bottoms were usually within a few percentage points, producing a small drawdown on average. And in almost every instance, stocks were higher within the following three months.
But it also indicated that things got bumper, he said, with realized volatility typically higher after the event.
Chintawongvanich took a stab at explaining why such eruptions of volatility tend to mark a bottom or at least a near-bottom. He concludes that, most likely, it’s because the downdrafts are more about liquidity — and the temporary lack thereof — than any sudden change in market fundamentals. He writes:
If the market suddenly has a huge selloff out of nowhere, then either 1) the economic fundamentals have instantly changed from yesterday, 2) the market collectively decided stocks are much more risky than they were yesterday, or 3) more liquidity was demanded than the market could provide. It is unlikely 1) fundamentals is the case today—most would agree economic fundamentals haven’t changed from a week ago. 2) higher risk premium could possibly be the case—after all, if 10-year yields are higher, perhaps the equity risk premium should be higher, there are some worries about earnings growth, margins, trade, and so on. But the real reason is probably 3) lack of liquidity, or more specifically that selling because of 1) and 2) led to a problem with 3). At any rate, if stocks are down because more liquidity is demanded than the market can supply, they should go back up once the liquidity demand goes away. That should be true whether the liquidity is demanded by “portfolio insurance”, CTA robots, or good old fashioned human traders.
But why are these events more frequent? Chintawongvanich said it’s possible that market structure has changed. That could come from the demand side, via increasing use of options and related products and strategies, or on the demand side from the rise of high-frequency trading and other developments.
Regardless of the reason, investors can at least take comfort in knowing it isn’t all in their heads.
The market last week hurt investors coming and going.
div > div.group > p:first-child”>
The 5.3 percent crunch in the S&P 500 on Wednesday and Thursday took the index back to early-July levels — inflicting buyer’s remorse on anyone who bid into the late-summer rally — while punishing the most popular huge growth stocks of technology the hardest.
In mid-week, an ear-splitting consensus that bond yields would keep rising drove the largest one-day withdrawal from BlackRock’s $53 billion flagship iShares Core U.S. Aggregate Bond ETF (AGG) on Wednesday – just in time for bonds to rally and yields settle back a bit.
Then came Friday’s rescue rally to thwart short-term traders’ geared for a typical Friday flight from risk. The major indexes lost a tentative morning rally only to carry higher in the final hour of trading by 1.4 percent to recoup a quarter of the preceding two-day loss.
It’s never an unambiguous call — and the market doesn’t always take the path of maximum frustration for the greatest number of investors. But at the moment it still appears the pain trade is to the downside — or, perhaps most diabolically, up first and then down harder.
First, on Friday’s comeback: It was impressive without being decisive. Stocks had quickly become substantially “oversold,” the S&P stretched far below its trend and the vast majority of stocks primed for a bounce. The fact that the market responded to these conditions — that it “bounced when it had to” is a net positive.
Thursday’s low, near 2,710 for the S&P 500, is certainly a plausible short-term low for a trading rally that can recover more of the recent losses.
But the damage to the big-cap indexes happened too fast for trader sentiment to grow desperately fearful yet. And it seems there might be too many observers clinging to the logic that seasonal factors now turn positive and earnings season will bring relief.
And are investors fixating too much on the idea that this was mostly just a nasty shakeout of crowded momentum positions held by performance-chasing funds?
It certainly was partly that, but the scapegoating of mechanical/technical factors shows a refusal to grapple with the possibility that the market was either too overvalued or is responding to signs of genuine economic deceleration.
The wishful expectation expressed by many investors that rising yields are a trigger for a long-awaited shift from growth to value stocks faces a high burden of proof. Leadership transitions at this point in a cycle are unusual, and would seem to require a significant market-wide retrenchment rather than unfold as a harmless handoff.
At the start of last week, 54 percent of the S&P 500 was in the S&P 500 Growth index, and 46 percent lumped into value. The market’s growth bet can’t easily be unwound without a net drop in total market value.
For what it’s worth, too, the S&P 500 fell more than 3 percent on Wednesday. In the past, 8 in 10 such drops came as part of a decline of at least 10 percent. So, it’s now a “show me” market, one that can no longer be trusted to do just enough to keep grinding higher through fortuitous sector rotation.
Jeff deGraaf of Renaissance Macro Research has been respectful of the market uptrend but on alert for a defensive turn in what he sees as a late-cycle environment.
On the path from here, with no clear capitulation but no obvious credit stress, “it’s a tough call,” he said. “Currently, with credit sanguine, we’re more confident in resumption of trend. Even if it is the beginning of the end, the playbook would be to see equities bounce further, challenge a new high (if not make one) before puking again.”
Credit markets sending no serious warning signals yet about the economy is one big thing distinguishing this year from the 2007 peak, when the S&P made a marginal new all-time high in early October, before a quick reversal made it look like a “bull trap.”
Of course, housing had been falling apart for more than a year by then, and the Fed had long stopped tightening in response. So we should relish the big differences, while also recalling that market patterns rhyme.
A different year is a bit more intriguing and less discussed as a possible analogy for 2018. Starting in the first quarter. I started citing the 2014 market as a possible map for this year:
While 2014 didn’t start as strong as 2018 did, both years had a February setback, were up around 2 percent at Memorial Day, made a record high in the third week of September for around a 9 percent year-to-date gain, then pulled back hard into mid-October. That October 2014 dump was blamed on a combination of Fed-tightening fears and the Ebola scare.
It recovered in a “V” pattern and powered to new highs through December to book an 11 percent annual gain — which most investors would take right now.
Of course, it closed that year essentially at the levels from which stocks would collapse into a quasi-bear market in late 2015 into 2016 that would undercut the entire fourth-quarter 2014 rally.
Not an outright prediction, of course. But from that October gut check it was eventually a painful trade — up, then down.
Global stock markets continue to fall as risk-off environment remains strong.
Asian stock indexes lost as much as 1.9% in Monday’s session, while European stocks nursed small falls in the first hours of trade.
US futures also point to a continuing slump in the US markets, with the Nasdaq set to start the week almost 1% lower.
Elsewhere, Saudi Arabia’s stock market has rebounded after a major fall on Sunday following the threat of US sanctions over the disappearance of a prominent journalist and critic of Riyadh.
Asian markets resumed their slump on Monday, with most major indexes across the continent losing more than 1% of their value during the first session of the week, and bringing back concerns of a global market correction following several days of losses last week.
After almost a solid week of falling stocks, global markets paused on Friday, with Asia, Europe, and the US seeing a significant rebound in prices. The slump, however, looks to have resumed in Asia on Monday.
The Shanghai Composite, China’s most important mainland share index, dropped 1.5% on Monday, while Japan’s Nikkei 225 lost 1.9% as the risk-off environment that permeated markets last week returned.
As well as losses in Asia, futures markets are pointing to another drop in all three major US indexes when trading begins at 2.30 p.m. BST (9.30 a.m. ET). The Nasdaq looks to be the biggest faller, with futures suggesting a fall of about 1% at the open.
“Just as you shouldn’t breathe too big a sigh of relief after earth tremors end, we remain anxious of a market that seems jittery,” analysts at Dutch lender ING said on Monday morning.
European stock indexes also saw losses in the first hour of trade on Monday morning, although their falls were minor. By 9.15 a.m. BST (4.15 a.m. ET) Germany’s DAX was down just 0.4%, while the FTSE 100 in London had trimmed 0.2% from its closing price on Friday. The Euro Stoxx 50 broad index of the continent’s biggest companies lost 0.3%.
Elsewhere, Saudi Arabia’s main stock market, the Taddawul, rebounded by almost 2% on Monday, following a major slump during Sunday’s trading session, driven by fears that US President Donald Trump may move to impose sanctions on the Kingdom. This would be in response to the disappearance of journalist Jamal Khashoggi in the Turkish capital Istanbul last week. Turkish officials believe he may have been murdered by Saudi agents.
Trump threatened “severe punishment” against Saudi Arabia if it is found to be involved in Khashoggi’s disappearance, which spooked investors, causing the index to fall as much as 7% at one point on Sunday.
On Monday, it has bounced 1.8% to trade at 7,397 points.
Trump’s threats have also driven the price of oil higher, reflecting concerns that US sanctions against Saudi Arabia could further threaten supply. Brent crude, the international benchmark, is 0.7% at $80.95 per barrel on Monday morning.
shed nearly 1,400 points in just two days last week, Desirae Odjick was calm and collected about the $50,000 she’s stockpiled in her retirement accounts — and the feeling hit her like a lightning bolt.
“That reaction was finally a wake-up call. I was like, ‘OK, I’m cool with risk,’” she told MarketWatch. Odjick logged into her robo adviser, Wealth Simple, and adjusted her account. She didn’t buy or sell anything; she set her account’s risk level up a few notches.
‘Most investors, particularly young investors, find out a lot about their true risk profile when markets fall.’
For Odjick and many other investors, this week’s market volatility has provided a powerful lesson on the true meaning of risk tolerance. It’s a concept that younger or less-experienced investors have only felt in the abstract as they built their portfolios during a bull market.
“Most investors, particularly young investors, find out a lot about their true risk profile when markets fall,” said Mike Giefer, a financial planner at The Johnston Group in Minneapolis. “When markets are going up like they have the past couple of years, everyone loves risk because they’re rewarded with investment gains in their portfolios. People often forget that markets don’t just go up and taking risk has consequences, including loss of account value amidst market volatility.”
Here are some key things to know about risk tolerance:
Questionnaires only go so far
When investors set up their portfolios, they usually fill out risk-tolerance questionnaires that aim to measure how they would handle a major loss, both emotionally and financially. Questions include, “If a stock lost 30% of its value, would you buy more, sell it all, or hold onto it?” The questionnaires also ask about how long you plan to work and your financial goals.
Portfolios with higher risk levels are generally weighted more toward stocks than bonds and may hold higher-risk investments in emerging sectors like cannabis and/or emerging economies.
The trouble is, people sometimes answer the more hypothetical questions inaccurately, either because they’re poor judges of themselves, or because they’ve never experienced that kind of loss firsthand.
‘Risk tolerance questionnaires are like flight simulators. A pilot might be able to simulate how they would respond in a crash, but in real life, it will be a lot different.’
“Risk tolerance questionnaires are like flight simulators,” said Randy Bruns, founder of financial planning firm Model Wealth in Downers Grove, Ill. “A pilot might be able to simulate how they would respond in a crash, but in real life, it will be a lot different.”
When Odjick, 29, first started investing three years ago she jumped in with both feet and set the risk level on her Wealth Simple accounts at 10 out of 10. But a customer service representative suggested that 7 out of 10 may be a more reasonable level, given her novice status.
“They told me, ‘You don’t have the proof points of how you react when the market goes loopy,’” Odjick said. The proof point came this week.
While headlines blared about the Dow’s third-largest one-day point drop in history, Odjick didn’t bat an eye. “It reminded me that following market news is not a solid investment strategy, but it also reminded me that my portfolio did need updating based on my risk tolerance.”
There’s a difference between risk appetite and risk capacity
There are two elements to risk tolerance: how much you’re willing to risk, and how much risk you can actually handle financially. Someone can have a strong stomach for market swings, but if they’re retired and need to tap their investments soon, they simply don’t have the capacity for much risk.
Bruns, for example, is 39 and doesn’t need to live off his investments in the near future. But he’s built his risk capacity by maintaining an emergency fund with enough money to cover six months of expenses and taking out long-term disability insurance that could fill financial gaps if he suddenly comes down with a serious illness.
A person’s appetite for risk is partly ingrained in their personality, but it can also shift because of external factors, says Monica Dwyer, vice president of Harvest Financial Advisors in West Chester, Ohio.
“At times I have found that there were clients that were going through some personal upheaval in their lives that was translating into market jitters,” Dwyer told MarketWatch. One client told her he was having trouble making market decisions after a cancer diagnosis, for example.
You should have some opinion on market volatility
If you were mystified by what the market’s roller coaster ride meant for you, that could mean that you’re out of touch with your own investment goals. Bruns sits down with clients and writes out an investment plan that includes a target rate of return, so his clients know exactly what they’re shooting for.
“Any time market volatility kicks in, if you don’t have a clue what return you even need to accomplish what you’re saving for, and you can’t make sense of why you’re investing the way you are, you’re just doing it all wrong,” Bruns said.
Get a daily roundup of the top reads in personal finance delivered to your inbox. Subscribe to MarketWatch's free Personal Finance Daily newsletter. Sign up here.