Assessing Your Investment Plan: 4 Questions to Ask

When volatility increases in the markets, it’s easy to second-guess your investment plan instead of assessing it properly.

The hallmark of a successful investor is the ability to focus on both the returns and the risk level of an investment. While the the introduction of negative returns is a reminder of the existence of risk, the assumption of risk is not simply a byproduct of investing. Rather, risk is a component of an investment strategy that should be carefully calculated.

If you're finding that you've neglected the consideration of risk when setting up your investing plan, it's not too late. Regularly revisiting and revising your investment strategy is just as important as examining its risk.

If your portfolio is causing you discomfort, it may be time to troubleshoot the cause. Here are four questions you can ask that will help you assess and improve your investment plan:

1. What Are Your Liquidity Needs?

Most investment portfolios are created with the intention of funding some future goal. Without a demand for the funds, investing would be incredibly simple: pick the highest returning asset over a long time of period, and hold onto it forever. However, once the concept of a time horizon is added, the focus shifts to the risk-adjusted return. This is used to maximize the likelihood of being able to fund future cash needs.

What are the liquidity needs for your investments? Do you have any major upcoming life events you will need to fund? This could be marriage, a new home purchase, college education, etc. Or maybe these are funds for retirement. When is that and what does it look like?

It’s important to classify each of these events as near, intermediate or long-term objectives. Identifying these needs and when they are likely to occur is one of the most direct ways to identify the type of risk you can handle.

Once you've identified your needs, the next question is how you will actually meet the funding needs of those goals. If you have a near-term need with a fixed-dollar amount, you might put those funds in less risky assets but take more risks with the remainder of your assets. Or if in retirement you need to withdraw 4% of the portfolio value annually, then you might structure your overall portfolio with a percentage allocation that produces income to fund some or all of that need.

Whatever the approach, knowing that you’ve addressed your cash flow needs first is an excellent way to feel more at ease when uncertainty around returns arises.

2. What Was Your Initial Investment Strategy?

Looking back on your initial ideas can be very meaningful in times of a pullback in an investment. It’s easy to focus on the difference between a current market value and what you paid for it, but what else has changed? There should have been more to your initial decision than just a higher expected future price. What were these factors and do they still hold true?

If you anticipated companies to do well or an industry to grow given a certain environment, do you still believe that to be the case? For example, maybe a change in the growth of the economy has delayed the expected outcome, but your original investment thesis still holds true.  

To the extent you are investing in mutual funds, exchanged-traded funds (ETFs) or other pooled investment products, do you understand what the underlying investments are? For example, knowing that a large-cap growth fund you hold is comprised of a couple outsized technology positions might go a long way in understanding why it has performed a certain way.

Perhaps most importantly, did you anticipate the current result as a real potential? When making an investment, it’s important to consider what could go wrong along with what can go right. This should entail some very real expectations of what losses could be likely to occur at any given point in time. Put this into real numbers and dollars. By doing this, you can point back to having this knowledge when making a determination to stick with an investment.

3. Should You Rebalance Investments?

Rebalancing your portfolio can be the ultimate gut check to an investor. It can be as much a psychological test as a prudent investment practice. If you were willing to hold a percentage of your assets in a certain investment at a prior time, now that the valuations have shifted why wouldn’t you be willing to bring this percentage back up? The psychological experience of loss can make this much harder than it might initially seem.

Rebalancing is generally not something to be overdone. It frequently includes a layer of costs, including transactional fees and taxes. There has also been plenty of research into allowing assets to have persistence of returns rather than constantly rebalancing them to targets. Still, without rebalancing, over time your allocation naturally shifts to the highest performing asset classes, which are typically also the riskiest.

Profit taking from a strong performer might feel easy for some, but adding back to an underperformer often proves more difficult. By going through the rebalancing exercise at times of increased volatility, even if only mentally, you can discover a great deal about your true risk tolerance. Take note of this information and do your best to apply it to investment decisions going forward.

4. What Do You Do After Assessing Your Investment Plan?

Diversification is one of the simplest ways to dial down the risk of a portfolio. Additionally, if you are unhappy with the results of a portion of your portfolio, knowing that you have other better performing investments to point to can go a long way for your peace of mind. Even with a diversified portfolio, there will be times when it seems that everything is down and nothing is reassuring. However, by having a process that includes a series of questions to ask yourself can help assure you that you are making well thought-out decisions rather than reacting emotionally to market swings.

Of course, there’s no magic solution to immediately recoup any losses you might have experienced. When you devised your initial investment strategy, you should have had an expectation of potential performance outcomes over long periods. This should have been paired with a risk metric that accounted for what you’ve experienced. The best way to achieve your long-term goal may still be to continue to stick with your current portfolio strategy.

If you find that you didn’t do the work initially or that you can no longer stick with the investment, then it’s time to reassess.

A successful investing strategy can always benefit from having experiences to draw from, and you now have a very informative one. Taking this new found information about your risk tolerance given your reaction to different market environments, you can now go to work to applying it to your investment strategy.

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