Ten Ways to Manage Financial Risk in Bear Markets

                                                                               

  

When meeting with a client, one of the financial advisor's first tasks should be to determine the customer's risk tolerance. In essence, this is a behavioral evaluation of the investor's comfort level with value fluctuations in their portfolio.

If a client is unable to withstand losses during a market meltdown, they may act hastily and against their long-term strategy, which could have disastrous results.

Strategy to take into account: Clearly describe your level of comfort with market changes upfront. To obtain a sense of how various market circumstances can affect your portfolio, discuss potential market scenarios using real dollar amounts rather than percentages.

Although less usually acknowledged, a person's ability for taking risks is just as significant as their risk tolerance. A risk-tolerant investor might choose to be more aggressive with their investing. However, employing an aggressive strategy may be foolish if they cannot take that risk, either due to time horizon or financial resources.

For instance, it would be foolish for a retired customer with a little nest egg to put all of their money into stocks or risky real estate investments. This client will have a hard time recovering their losses if things don't work out. On the other hand, a youthful investor with a big salary might be okay with using an aggressive approach. They will be better positioned to earn bigger returns than they would with a more cautious portfolio, and if their portfolio falls, they will have the time and means to ride out the slump.

This is about numbers, so think about your strategy. Find out how long you intend to work, your wages, your earning potential, and the size of your emergency fund. If every one of these factors is in your favor, you might be able to accept more risk.

This is the brief decline in the market value of an investment. In the stock market, it takes place every day. A stock or mutual fund's price may have increased while falling for another. Although there is a chance that prices will drop significantly and stay low for a while, this risk is not long-lasting.

Consider this tactic: This risk cannot be avoided. These kinds of fluctuations will be felt by everybody with investments in liquid securities. Investors can weather any brief decline in their portfolio by keeping a sizeable cash reserve in their checking account.

"Deep risk" refers to a genuine capital loss that you are unlikely to recover. This, according to financial expert Dr. William Bernstein, is the outcome of deflation, confiscation, inflation, and destruction.

The destruction of property due to conflict is one example. Confiscation may result from higher taxes or the government seizing your assets. Deflation is a decline in asset value, as was observed in Japan. Finally, as prices for goods and services rise, you lose purchasing power, which is at a 40-year high.

Strategy to consider: All of them are frightening to consider, but for the majority of investors living in the United States, inflation is the only serious worry. The Federal Reserve can prevent deflation by supporting the markets. In the US, the likelihood of confiscation and destruction is lower. Although our government can be criticized, it is a rather stable structure. However, we are all currently experiencing inflation. Equities, which have historically outperformed inflation over the long term, should be overweighted in a diversified portfolio to help reduce inflation risk.

When you put all of your money into a small number of investments, you run the risk of losing money. For an investor who is compensated in the stock of their employer, this might naturally happen. They gather so much over time that a sizable portion of their portfolio is made up of it.

Others have made it a conscious decision. Given their rapid increase over the 11-year bull market, many investors flocked into tech equities. The Nasdaq tech-heavy index has, regrettably, declined by around 30% over the past year, which is disastrous for people who do not have enough investments outside of this asset class.

Strategy to consider: One strategy to reduce the volatility in your portfolio is to use proper diversification by owning several investments kinds in various sectors and regions.

This is the risk associated with being unable to sell your investments at the desired price. For instance, it may take months to sell some illiquid investments like private equity, hedge funds, real estate, and artwork. With these possessions, an investor might encounter difficulties if they suddenly required money.

                                                                                   

Strategy to consider: Make sure to mix and match liquid and illiquid investments. As previously noted, having a financial reserve is usually beneficial, but in difficult circumstances, that may not be enough. Any portfolio would benefit from adding blue-chip equities and top-notch bonds since they provide liquidity when needed.

Bond investments, for example, run the risk of the government or firm issuing them being unable to make interest payments or principal repayments when they mature. Bonds of poorer grade carry a larger risk of default despite having higher potential yields.

Strategy to consider: You can assess credit risk using the ratings of the bonds you possess. Bonds with the lowest credit risk get the highest credit rating of AAA. Bonds with ratings below BB+ are categorized as trash and have a higher probability of default. Before investing any money in trash bonds, make sure you can afford to lose it.

Bond prices and interest rates are inversely correlated. Bond values often decline as the Fed increases interest rates. That was evident in 2022 when the rapid rate hikes caused double-digit losses on investment-grade bonds.

Bonds are considered the "secure" portion of an investor's portfolio, so it might be unsettling to see their value decline.

Reduce the duration of the bonds you hold as a strategy. The weighted average period until the bond's fixed cash flows are received is known as the duration. It can be used to gauge the risk associated with changing interest rates as well as how much bond values are anticipated to fluctuate. Your bond holdings will be less affected by a change in interest rates the shorter their duration.

Your investing time horizon may alter as a result of an unforeseen life event, such as job loss, incapacity, a loved one's passing, or a sizable unanticipated bill.

Strategy to consider: Proper life, disability, house, and umbrella insurance coverage can provide security against unforeseen occurrences like early death, disability, or expensive hurricane-related property repairs. It can be more difficult to safeguard against the possibility of losing your work. However, a sizeable cash reserve and the readiness to drastically reduce spending and alter your lifestyle may be able to lessen the upcoming financial difficulties.

Outliving one's nest egg is the main worry of many retirees. Nobody wants to be in a position where they have to rely on their family, friends, or charity.

Strategy to consider: A multifaceted strategy is necessary to reduce longevity risk and make sure you have enough money to last. This includes delaying Social Security, working longer, exploring guaranteed income through an annuity, purchasing long-term care insurance, and determining the most affordable location to retire. It also includes contributing money from every paycheck to tax-advantaged retirement accounts. None of these recommendations are simple, and some call for lengthy planning.

However, their combined effect can enable you to lead a respectable retirement life without worrying about running out of money.

Different weaknesses in our financial strategy can become apparent in trying market conditions. Failure to evaluate risk or incorrectly identifying your risk tolerance are common causes of errors.

Although finding these mistakes is painful, taking preemptive measures to fix them might assist safeguard your finances during the subsequent market collapse. More importantly, it will raise the likelihood that you'll reach your financial objectives.

Securities are provided by FINRA/SIPC member Kestra Investment Services, LLC (Kestra IS). Kestra Advisory Services, LLC (Kestra AS), a subsidiary of Kestra IS, provides investment advisory services. Kestra IS and Kestra AS are unrelated to Shenkman Wealth Management.

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