Am I Taking Too Much Risk?

Am I Taking Too Much Risk?

Now that we find ourselves on the low end of the trading range for the year, some investors are asking if they should remain invested in the market. Interestingly, when the market is up, I’ve only been asked this question once.

The investing ideal is high returns with no risk. I want to take a moment to break down what this means on a gut level:

We want to invest $5,000 today and achieve the wealth necessary to buy a mansion, a yacht, a plane, and three gourmet meals a day in short order. And why not? It can’t hurt to dream…can it?

Actually, it can. This concept is so attractive that investors are frequently harmed or destroyed by this promise. The investor who chooses to believe in big returns with little or no risk is more likely to fall prey to Ponzi schemes and other scams.

Intellectually, most realize there is no such thing as a free lunch. Most investors understand that, if done prudently, taking more risk raises the opportunity to achieve higher returns. Taking less risk minimizes potential losses but nearly insures losing out on the highest returns. The words, “risk” and “return” go together…always. It has been said, “Risk is really fortune’s accomplice.”

In everyday life, "risk" carries a different connotation. It refers to the chance that something bad will happen. This includes actions that present little gain to accompany the risk, such as climbing Mt. Everest (many people die attempting this feat) or raising a 2 iron (yes, some of us still have one in the bag) above your head in a thunderstorm.

In business and investing, you can't have greater returns without taking greater risks. This is precisely the reason we are seeing stories about stifled job growth and manufacturing. In times of uncertainty companies are more concerned about maintaining a foothold than reaching the summit. The summit is still the goal, but industry looks for more than a scary story with bragging rights. It wants a summit covered with money.

As an example: In 2009 Apple stock was trading at $80 a share. Tablet computers, small devices with no keyboard and little memory, were failing left and right - including Apple’s own Newton. There appeared to be no market for the tablet.

Apple, convinced that smaller computing and “under the arm” internet linkage would ultimately be successful, took a risk. A huge risk in that the development and production cost of the iPad could have crippled the company if the product failed. After its release in 2010 the stock price tripled and Apple redefined personal computing.

When investing, risk refers to price volatility within a fluctuating portfolio. It's not the chance something bad will happen as a result of reckless action - but the potential magnitude of temporary failure that accompanies bold action. Downside volatility is an inevitable part of upside return.

The market, economy, and our political environments are not ideal at the moment. The situation begs our inner analyst to begin speculating on everyday risk, the next bad thing that could happen. If we broaden our view just a little, we see stock investors are up nearly 100% from two years ago. A larger step back reveals Apple trading at $7 a share ten years ago.

As investors, our second smartest decision is to not run from risk but to buy and hold these bold investments appropriate to our investing time horizon. The smartest decision we can make is to actually buy more of these investments when prices are dropping if we are able.

“Be fearful when others are greedy, and greedy when others are fearful.”

-Warren Buffet

Properly managed, these investments have always been the greatest wealth creators and most likely will continue to be-- as long as our way of life doesn’t end. In the event that actually does happen, it won’t matter where you have your money.

I welcome questions and comments.

Warmly,

Marc Becker