Dear Advisory Client,
The market, economic and business conditions have caused the value of your portfolio to fall, with a few individual stocks seeing substantial erosion in value and negating any gains that have come from stocks that have performed. It is unpleasant to see your savings coming off and this causes different levels of reaction among investors.
The first reaction is a freeze in further investments, the second is to sell stocks that have fallen sharply in value and the third and extreme reaction is to sell the full portfolio and stay out of the market.
The question of risk tolerance comes into fore in such pessimistic environments. Risk tolerance is measured by quantum of loss in portfolio, the ability to hold on to investments and by the emotional stress in seeing the drop in value of savings.
On the quantum of loss in portfolio, most investors believe that that can see portfolio values drop by 20% to 25%, but when it does happen, the ability to tolerate risk drops sharply. This can lead to sub optimal decisions.
The ability to hold on to investments is defined by the need for liquidity and if investments are made from a longer term perspective, selling the portfolio in order to buy back stocks at a later period becomes a case of timing the market.
On the emotional side, if portfolio volatility is causing too much of stress, then it does make sense to cut losses even if risk tolerance and ability to hold on to investments are high.
Such periods of volatility in markets will always be there but these are the periods when stocks tend to bounce back from lows and scale new highs and long term investors reap the benefit of holding on to good portfolios even if there are sharp drops in value of few stocks.