The historic drop in the markets that has taken place over the past year has even the most seasoned investors shaken. Very few investors have ever seen a bear market of this stature during their investing careers, and one has to wonder whether overall risk tolerance has changed for good.
Personally speaking this bear market has reinforced the idea of having a proper asset allocation. I’d say even the most aggressive investors with long time horizons would benefit from having a minimum of 10% of their portfolios in bonds to lessen volatility. For those investors closer to retirement, a portfolio consisting of 40-50% bonds would be more appropriate. A proper asset allocation won’t prevent you from taking losses during severe bear markets, but it will ensure that you live to fight another day.
Here’s an interesting piece from the New York Times that examines how our current crisis is changing the way investors look at risk.
[...] See more here: Has Investor Risk Tolerance Changed Forever? [...]
A little off-topic, but worth mentioning, I think. I watched Frontline on PBS last night, “Inside the Meltdown” (can be watched online here: http://www.pbs.org/wgbh/pages/frontline/meltdown/) and thought it was one of the best explanations of how we got to where we are. If focuses in-depth on the market forces that brought down Bear Sterns and the subsequent collapses of Freddie Mac/Fannie Mae, Lehman, etc. It also explored the relationship between Hank Paulson and Ben Bernanke, which I found interesting and also looked at the actions Tim Geithner took as the head of the NY Federal Reserve around the Bear Sterns collapse.
I’ve wondered about the risk tolerance of our generation as well; if it will have a permanent effect on some people and that they will pass off this risk-aversion to their children, and continue down the line.
My first thoughts were that our parents perhaps never experienced such a market, and therefore never could adequately verbally prepare us for such possibilities as this market. But then I reviewed the past bear markets, there was the crash of 73-74; a drop of 46%, and it didn’t reach its previous level for 5 years. Something we can easily expect with this one. I guess I didn’t feel the effects of that from my parents because my father/grandfather worked on Wall Street (and my grandfather that had worked through the depression/Crash of 29) and ultimately was taught to have the patience and discipline to have faith in the market long-term (and assumed no other my age was affected either). But now I wonder how many Gen Y’ers don’t invest in the stock market, not because they or their parents aren’t familiar with it, but because their parents/grandparent avoided it specifically due to a crash in their own lifetime. If this were the case, I guess we’d be losing more and more investors down the line each time. I guess if the market isn’t learned at home, theres school (but rare if your not in a related major), friends, work (retirement plans), and other means, but are there people out there that still avoid it altogether?. I do wonder how far a crash can cause distrust in the market down a family line, and if subsequent crashes in each descendants’ lifetime reinforces that distrust. Do these parties ever gain trust in the market and enter (besides the ones who enter in the hype of bubbles and are guaranteed to hate the market after), or does all growing wealth in the market come from a decreasing percentage of those who are firm in their faith in the market, and therefore, the long-term market truly does benefit and increase wealth of those who stick with it? I think it would be an interesting study; not that I’m about to undertake that duty.