Should I be investing more aggressively at this time?
I have a frozen 401(k) with $108K from a former employer that was consumed by a bigger entity. I now have a 403(b). I am 50 years old with the goal to retire at 68. I am currently in a moderately aggressive plan. Would it be wise to increase to a more aggressive plan given my age and the current state of the economy? I see the returns of late being better and wonder if even for a short time, it might be of benefit?
In my 17 years in the business, I have come across many investors who were "aggressive investors" until their first big drawdown, then they were "conservative investors." The caution is to know how much risk you are willing to take, then compare that to how much you actually have. If your account is all equity funds, then you may have as much as 50% risk. I say this because the major indexes have declined by that much or more twice in the past 17 years. While this doesn't mean it will happen a third time, we also should not be surprised if it does. This is where asset allocation becomes key to risk management. Without detailed knowledge of a person's situation, investment choices, time horizon and so on, it is difficult to render an informed opinion. Consider finding an investment professional willing to work on an hourly basis to help you work through these important aspects. Then, you will be able to make an informed and rational decision that is in your best interests.
On the surface, an aggressive plan might seem like a good idea. But in fact, it’s a trap I’ve seen many investors fall into.
From my perspective, there are three problems with this approach.
The first is that markets are notoriously unpredictable.
In fact, they almost always do what we least expect. A good example is the recent Trump election and surprising stock market rally. Who expected that? While it is true that the markets have been doing well, we cannot be sure how long this trend will continue. But what we do know with absolute certainty is that if you increase the risk in your portfolio, you will experience more volatility. You will also experience greater declines when the next downturn comes. And it will come. But investors who are inclined to take more risk when times are good often believe they can avoid market declines. They believe they can ratchet the risk back down before things get too bad. Although this is a compelling idea, it is far more difficult to accomplish than you might expect. Most investors who travel this path wind up doing more damage than good.
The second problem we encounter is that markets are far more volatile than most people realize.
In fact, on average the S&P 500 is down 14% at some point every year. I know it sounds impossible but it is true. If the market is down that much at some point every year, it’s not reasonable to expect that you can increase your risk while the markets are doing well and get more conservative before things go down. Don’t get me wrong, some people will attempt this and they will succeed on occasion. But in my experience, this is no better than gambling and will inevitably yield the same unpleasant results.
The third problem in tying your investment allocation to market conditions is that market conditions are always changing.
If your philosophy is to be more aggressive when the market is doing well, what do you do when you are surprised by a significant market decline? Do you hold? Even if the market continues to decline? If so, for how long?
As you can see, trying to play catch up with your investment portfolio is likely to do you more harm than good.
You should become less aggressive, not more. Regardless of your age, U.S. equities as a group have rarely been more overvalued. We are likely to have a bear market in 2017-2019 which is similar to the ones in 2000-2002 and 2007-2009. You should go for the most guaranteed income with the least risk.
When deciding how to invest your savings, remember that your risk ability and risk willingness are the two primary components when selecting a proper asset allocation.
Risk ability is quantitative and relates to your capacity to achieve your financial goals based upon the evaluation of data – the size of your investment portfolio and the impact that increased volatility will have on your ability to achieve your goals, your time horizon (both pre and post retirement), anticipated short term liquidity needs, etc.
Risk willingness is qualitative and corresponds to your emotional level of comfort with market volatility through different market cycles – How would loosing 36% of your portfolio’s value in a 12 month period make you feel? What would you do if that happened? Both risk ability and willingness are important factors in determining your asset allocation.
As your portfolio drifts away from this strategic allocation due to market movements, you should then periodically rebalance by selling assets that have richened and buying assets that have cheapened.
Rebalancing is a far better method than engaging in Tactical Asset Allocation (“TAA”) decisions such as increasing the risk profile of a portfolio in response to positive market returns. TAA calls have a low probability of being correct. This is mainly due to the fact that in the short term: 1) There can be many catalysts for market direction and many are anything but rational and; 2) Valuations seem to only matter over the longer term.
TAA decisions tend to be emotional and often driven by the investor’s desire to simply do something in response to the market’s actions. Finally, entering into a TAA is the easy part. The hard part is knowing when to throw in the towel on a "loser" and almost equally as difficult is knowing when to monetize a "winner."
I would suggest determining what your optional risk profile is by thoroughly examining your long-term financial goals and allocating your portfolio accordingly.
The stock market is currently at an all-time high, but it has continued to rise overall with much better returns than bonds (which could drop in value with additional interest rate increases). So, the possibility of a significant drop in the near future should not be a surprise. At the same time, waiting or selling can be a huge opportunity cost as we saw the rapid recovery of the 2008 crash. If you are willing to tolerate more risk and have some time to recover, you could select a more aggressive portfolio. However, you may want to diversity that risk with an appropriately balanced ETF portfolio that also has some bond funds to help cushion downside risk. This can also be done in a separate Individual account while you max any employer matching contributions.