When the stock market is rising—as it has been for much of the past 5 years—it’s common to think that you should be taking more risk with your investments. When the stock market goes down, it’s common to think the opposite. But constantly shifting around the amount of risk you’re taking in response to how financial markets are doing is a recipe for poor long term performance. A better idea is to take a longer-term view of the risk you want for your portfolio and stick to that risk level.
There are two main problems with constantly shifting around how much risk you’re taking. One is that it’s very difficult to do successfully. It’s natural after markets have rallied to regret not having taken more risk. But the better time to take more risk would have been before the market went up, not after. Increasing the risk of your portfolio after markets have gone up simply puts you in a position for larger losses when the markets reverse course.
A second problem with shifting your portfolio’s risk in response to what markets are doing is that your portfolio can easily become disconnected from your real-world financial goals. If you’re investing money that you plan to use in the near future, it may be a good idea to take less risk to ensure that your portfolio won’t lose a large amount of its value shortly before you need the money. Remembering this may be more difficult when you’re constantly shifting around your portfolio’s risk level. If your financial goal has a short time horizon and you happen to take on more risk right before markets decline, you put yourself in danger of not being able to reach your goal.