Take a look at this screen shot:
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:
- Wow, look at those gains!
- Wow, look at that loss!
- 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:
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?