Millennial college graduates in 2018 were in middle school the last time the markets saw prolonged volatility. As investors, they are comfortable putting their money in speculative investments. But they need a better understanding of portfolio diversification for times of instability. (Photo: Shutterstock)

Last month investors saw an unfamiliar color when they checked their brokerage accounts: red. Worries over rising interest rates and geopolitical concerns caused investors to flee stocks and move into more stable options like cash and bonds.

This is exotic to some investors, after witnessing the economic climate over the past 10 years. In fact, the market has seen uninterrupted growth for over 3,453 days, surpassing the previous record set between 1990 and 2000.

To put this in perspective, millennial graduates who finished college this past spring were in middle school the last time the markets saw any kind of meaningful or prolonged volatility.

There is a strange dichotomy within the millennial generation, whose years of birth span between 1981–1996 (22–37 years old). Older millennials are still scarred from the 2008 'Great Recession,' which occurred as many were entering the workforce.

The magnitude of market collapse during the Great Recession has caused many of these investors to hold large cash balances in their investment accounts, hindering their ability to accumulate wealth.

Alternatively, younger millennials came of age in a market that has grown by over 300% since March of 2009. As investors, they are comfortable putting their money in speculative or overpriced investments. A strategy like this is sure to cause panic once the market cycle turns negative, which it eventually will.

Moving forward, young investors need a better understanding of portfolio diversification that will afford them growth opportunity while also preparing them for times of instability.

Continued conflict between the US and its trade partners, political uncertainty in the US and abroad and the end to the Federal Reserve's accommodative monetary policy create uncertainty which, in turn, results in market volatility. This is nothing to be afraid of, but it is something we must be prepared for as responsible and educated investors.

Fortunately, investors in the millennial generation have plenty of time to accumulate wealth and weather the turbulence of market cycles.

Now is the best time to start planning, but where do you start? Here are a few questions you need to answer before making any decisions:

1. What are your goals?

The start to a sound financial plan begins with an understanding of your goals. Millennials don't need to stress about the details of their retirement; however, they do need to ensure they are putting an adequate amount of money away to prepare themselves for that day.

It is appropriate to put a bulk of this money in equities, as younger investors have plenty of time to recoup losses that occur in market downturns. Over time, the allocation to more volatile assets should be trimmed as one approaches retirement.

Millennials do need to focus on expenditures that will occur in the near future. This would include an emergency fund, which is the foundation of a strong financial plan. An emergency fund should allow you to cover at least 6 months of expenses should an unfortunate event occur among you or your family (loss of job, illness, accident, etc.).

For those whose income and/or expenses are less predictable, a 12-month cushion may be more appropriate. Along with an emergency fund, you should focus on certain life decisions like buying a house, buying a car or planning a wedding.

Events like these have a shorter time horizon which will impact your strategy for savings and investing to meet these goals. It is important that investors don't leave money in their checking accounts for these mid-term expenses. As inflation rises, those left in cash will be losing money as the purchasing power of their savings decreases.

2. How much can you part ways with?

Once your goals are defined, you need to look at your monthly income and expenses to understand how much can be saved each month. For some, this may be saving 20% of their paycheck, while others may have more cyclical income or expenses.

Whatever it may be, a plan must be set in motion so you are allocating enough capital to the appropriate areas in order to meet your objectives.  It is important to get into the habit of saving early, balancing your needs today with your needs of the future.

3. How much loss can you tolerate?

When creating your investment allocation, you need to consider a strategy that will allow you to meet your goals without leaving your risk comfort zone.

For example, a portfolio designed for long-term growth with over 10 years on to mature may have an 80% allocation to equities. While this can offer a better opportunity for long term growth, it will also experience considerable fluctuation as the market moves through its cycle.

To put it in perspective, a portfolio of this nature would have lost nearly half its value during the most recent bear market from 2007-2009.

Investors must be sure that they can stomach losses of this magnitude and avoid panicking when the market turns. It's normal for the market to go through cycles, and young investors who have not experienced a bear market will need to understand that.

You don't have to make drastic changes to your investment strategy—assuming it's appropriate for achieving your goals—just because we're in the late stages of a bull market.

But you should ensure that you have realistic expectations and that you and your strategy can withstand during periods of negative performance.

Mitchell Lamoriello is a research analyst with LAMCO Advisory Group.

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