Every market sell-off is scary. When stock markets fell more than 35% earlier this year, what was it like for you — did you lie awake at night worrying? Did you panic and cash out?
The pandemic has hit physicians hard. For those working with or near COVID-19 patients, there’s the worry about getting sick or passing the virus to their families. For others, there’s the reduced practice hours and loss of income because of physical distancing. And to top it off, there has been the precipitous drop in the markets.
After enjoying a bull market for a little more than decade, investors are feeling the shock. Amid global uncertainty about the pandemic’s economic impacts, this market downturn may be an opportunity to ask yourself: Have you overestimated your risk tolerance?
What is risk tolerance?
“Risk tolerance” is a qualitative assessment of how much volatility — i.e., loss — you’re able, and willing, to endure when investing.
Typically, when you set up an investment account with a financial institution, you are asked about your risk tolerance to help the advisor or institution determine the type of holdings that will be suitable for you, as part of your investment or financial plan.
As time passes and things like your income level, career stage, time horizon and experience change, you need to reassess your risk tolerance. For instance, early career physicians, with more time to invest, would likely have a higher proportion of equities in their portfolios than retired physicians, who need the income generated from their portfolios now.
Your risk tolerance is assessed using a combination of objective and subjective factors. Objective ones include your age, income, assets, debt and number of dependants.
Subjective factors require a self-assessment. They include your:
- investment time horizon (how long can you invest before you need to use the money?)
- investment knowledge
- investment experience
- investment objectives (what purpose will you use your money for?)
- feelings about certain market events, like major market drops of 10% or more
If you haven’t lived through the ups and downs of a full market cycle, these self-assessments may feel like guesswork, especially questions like “How would you feel if your investments dropped by 20%?”
For this kind of question, it’s better to translate the percentage loss into a dollar figure. When you start investing and you have $1,000 invested, a 20% loss may not seem significant, but as you continue investing and you accumulate assets, the pain of losing 20% on $1 million might seem intolerable.
Revisit your risk tolerance
Trying to assess your risk tolerance accurately can be challenging.
Behavioural economics tells us that people may be good at guessing the type of emotional reaction they will have (e.g., anger, fear, disgust) but they’re less accurate when predicting the intensity and duration of their emotional reactions.1
What the downturn during this pandemic can do is make you more aware of your true risk tolerance. You can consider resetting your strategy if you’re not comfortable with your current level. Be aware, though, that a market collapse will make some investors panicky and overly risk-averse. You don’t want to make emotional, reactive decisions in a period of uncertainty.
Talk to your MD Advisor* about your unease and whether now is the time to adjust your portfolio and financial plan.
If you decide to rebalance your portfolio (selling/buying) to a more suitable risk level, remember that there could be tax consequences. If you have a corporate account, it could impact your capital dividend account.
Remember, there’s a reason risk tolerance assessments weigh both objective and subjective factors. While you might be able to afford to be a more aggressive investor, the risk may not be worth it if you can’t sleep at night.
If you have any questions about your risk tolerance and your financial plan, please contact your MD Advisor.
*MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.
1 “Affective Forecasting.” Advances in Experimental Social Psychology, 2003, pp. 345–411., doi:10.1016/s0065-2601(03)01006-2.