The Market is Volatile. Hang on for the Ride!

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Take a look at this screen shot:

The Stock Market is Volatile
(Click “display images” if you’re reading this by email).

That’s an actual screen shot of my stock portfolio, taken on Oct. 5, 2011. At the time, Apple stock skyrocketed 141 percent since the time I bought it. Goldman Sachs plummeted 42 percent.

What’s your interpretation of this? Are you thinking:

  1. Wow, look at those gains!
  2. Wow, look at that loss!
  3. Wow, check out that volatility!

If you answered “A” or “B,” you’re either an optimist or a pessimist. But if you answered “C” — check out that volatility! — you have a balanced understanding of what happens when you try to choose individual stocks.

You win some, you lose some. And the wins and losses can be enormous.

Individual stock-picking is a completely different animal from buying an index fund. With the exception of HUGE market upsets (like the Great Recession of 2008), your passive-managed portfolio probably won’t have such wild swings.

Your individual stocks will. Just take a look at what happened to Google in the past five days:

Google's volatile stock price

(Does anyone else think it’s funny that I used Yahoo Finance to look up Google’s stock price?)

On January 19, it closed at $640 a share. On January 20, it opened at $590 a share. It lost $50 per share in a single day!

Why? I have no idea. Which is why I’m not playing the individual stock-picking game.

Sure, I bat around with some “fun money.” (Notice, in the first screen shot, that my stock investments are low-dollar.) I’m only using “fun” money. It’s my (nerdy) equivalent of splurging on a vacation. (Except instead of lounging on the shores of Bora Bora, I’m researching company earnings. Spring break 2012, baby!)

Hitting the Risk/Reward Sweet Spot

In the risk-reward continuum, index funds are moderate. You won’t win big, but you probably won’t lose big, either. You trade potential gain/loss for stability.

That’s why so many people (including me) use index funds and exchange-traded funds (ETFs) as the core of a long-term growth strategy.

Don’t accept that advice as dogma. It’s important to understand WHY.

Many people — including me — think that broad-market index funds and ETFs hit the “sweet spot” at the tradeoff of risk and reward. It has good long-term reward potential, and modest risk.

It’s a get-rich-slowly method. It won’t make you an overnight millionaire, the way individual stocks can. But it probably won’t make you a pauper, either.

What if your thrill-seeking side can’t resist a few gambles on individual stocks?

You can always wager your vacation money on it. :-)



P.S. Check out this Quiz: What’s Your Risk Tolerance?

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22 Responses to “The Market is Volatile. Hang on for the Ride!”

  1. Monica
    23. Jan, 2012 at 2:06 pm #

    What a great way to demonstrate an investing philosophy! I don’t think anyone can accurately predict what will happen with the market, and I believe that volatility is here to stay. You have the right idea when it comes to investing, too many people want to “strike it rich” overnight, but that is not reality.

  2. Jeffrey
    23. Jan, 2012 at 3:22 pm #

    I agree that index funds and ETFs “hit the sweet spot” for me, too. Plus I just don’t want to put in the time to deal with stocks, and I’m not even sure I’d be better off if I did.

  3. Chris
    23. Jan, 2012 at 3:39 pm #

    A great book that discusses the tradeoff between risk/reward and modern portfolio theory is The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William Bernstein. I’m currently about halfway through it and learning how to establish the best portfolio for me. It’s a little technical at times, but definitely a recommended read :)

    • AffordAnything.org
      24. Jan, 2012 at 12:20 pm #

      @Chris — Thanks for the recommendation! I’ve heard of William Bernstein; I suppose he’s one of the better-known names out there. I’m hoping to read him, Ben Graham, Phil Fisher, Pat Dorsey and many more investing authors this year. :-)

  4. DollarDisciple
    23. Jan, 2012 at 6:24 pm #

    I would say that it’s actually three-dimensional: risk vs reward vs time! Index funds therefore strike a balance between all three.

    To Jeffery’s point as well: unless your bankroll is pretty large, the extra gains which might result from a ton of research look pretty small when reduced to an hourly rate. Most people would probably benefit more from getting a part time job and investing their checks instead of spending that time researching individual stocks.

    • AffordAnything.org
      24. Jan, 2012 at 12:25 pm #

      @Dollar Disciple — I agree 100 percent !!! I think my time is much better spend earning extra money and putting that money in index funds. If I spend many many hours researching stocks, and my portfolio ends up with a 15 percent gain rather than an 8 percent gain … well, as an hourly rate, that’s not very much money. :-)

      • JP
        26. Jan, 2012 at 5:11 pm #

        It can be very much money. Over ~30 years averaging 15% instead of 8% will multiply your ending balance significantly.

        Plug into any retirement calculator and check the difference.

  5. Kanwal Sarai @ Simply Investing
    23. Jan, 2012 at 11:15 pm #

    There are 3 big investing myths, that I’m trying to abolish:

    - stock picking is risky
    - stock picking is time consuming
    - stock picking is complicated

    All of the above myths are true if you don’t know what you are doing. All it takes is a little bit of education (not a university degree) in order to invest successfully. It’s too bad we are not taught how to invest in stocks responsibly. This stuff should be taught in high school, on how to invest in quality dividend paying stocks when they are undervalued.

    The same can be said of real estate investing. Without any education, real estate investing can also be risky, time consuming, and complicated.

    • AffordAnything.org
      24. Jan, 2012 at 11:46 pm #

      @Kanwai — A person who commented on this post, using the name “Dollar Disciple,” said it best:

      “unless your bankroll is pretty large, the extra gains which might result from a ton of research look pretty small when reduced to an hourly rate. Most people would probably benefit more from getting a part time job and investing their checks instead of spending that time researching individual stocks.”

      That remark pretty accurately sums up my feeling about individual stock-picking. I think that knowledge/education (not the kind you get in college, but the kind you get from reading books, talking to investors, etc.) can alleviate the risk. BUT, gaining that kind of knowledge takes time, and I think my time could be better spent earning more money and/or investing in real estate, where I can leverage my limited cash.

  6. PKamp3
    24. Jan, 2012 at 11:41 am #

    D. I wonder how many other tech stocks she invests in?

    Haha, they are good companies, however. I generally don’t touch tech companies myself since I work in the industry and I’m trying to keep industry risk out of my vocabulary.

    I do make room for individual stocks as a significant part of my portfolio. As you can imagine, you have to watch closely. Caveat emptor!

    • AffordAnything.org
      24. Jan, 2012 at 12:18 pm #

      @PKamp3 — I personally don’t want to take on that kind of risk. A little ‘fun money’ is okay, but I personally don’t want to put the bulk of my portfolio in individual stocks. … maybe one day, if I’m retired on passive income, I’ll try my hand at trading full-time :-)

  7. femmefrugality
    24. Jan, 2012 at 2:03 pm #

    Need to learn more about stocks…thanks for the tips broadening my horizons.

  8. Anree
    24. Jan, 2012 at 5:58 pm #

    I have held individual stocks and traded options in the past. I won and I lost. I believe that the entire experience could be aptly described as “volatile”.

    There are a couple of reasons I don’t invest or trade individual stocks anymore:

    1. My financial goals do not require the out-sized gains that individual stocks have the POTENTIAL to return. If my goals only require the market average return, why would I subject myself to the unsystematic risk of individual stocks to eek out a few more percentage points?

    2. I believe that financial markets are efficient and all known information is currently reflected in today’s stock price. So, in effect, I would be betting on the future news for a particular company, which is unknowable and subject to a multitude of variables. Do you really know something about the company that the guy/gal on the other side of the trade doesn’t? (Probably not, especially, if they are a professional market maker.)

    In short, I agree with you. Consistently beating the market averages year after year, particularly after costs and taxes, is an increasingly difficult proposition. For most of us, a low-cost diversified mutual/index funds is a much better long-term strategy.

    “Don’t confuse genius with a bull market.”

    P.S. I am fan of Google but don’t own any shares outside of the S&P 500 index. Apparently the stock took a hit after reporting earning less than expected (but still highly profitable). I guess the European crisis has hampered the company’s global growth. I think this proves your point though. I still don’t fully understand it and surely couldn’t have predicted the market’s response.

  9. jlcollinsnh
    25. Jan, 2012 at 10:26 pm #

    Hi Paula…

    just wandered in following a comment you made on another site. Been poking around a bit, great personal story and well done articles.

    I’ve actually traveled to your home country. Beautiful place.

    Glad to read your thoughts on indexing. Like you, that’s where money market money lies. But, with some embarrassment, I also admit to playing with some individual stocks. But even when, like last year, I win it is a dangerous game. I start to think “man, I’m pretty good at this and it’s easy.” Pain and loss lie down that path.

    You might like this one of mine:
    http://jlcollinsnh.wordpress.com/2012/01/06/index-funds/

    Cheers!

    JC

  10. jlcollinsnh
    25. Jan, 2012 at 10:27 pm #

    meant to say: where my market money lies.

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