There has been alot of discussion lately about investing and its risks. Negative returns and unfavorable market conditions have caused many people to conclude that investing is unsafe and unprofitable. Saving, with its guaranteed return is thought to be more sensible.
The examination of the word risk is a good beginning for this newsletter. Risk is the chance of being harmed or being exposed to danger. In its strictest meaning it is incorrect to say investing is risky.
When people say risk they mean volatility. Volatility is the fluctuation in value of your investment. The value of an investment can fluctuate a lot, (major roller coaster ride), which is an aggressive investment or a little, which is a conservative investment. There are degrees in between.
The volatility of investments in recent times has made major headlines. It must be mentioned at this point that the real news has been the many more companies that have quietly been profitable despite the market downturn. Many people have concluded that the roller coaster ride has given them too much of an upset stomach and that they’d prefer the tamer totally horizontal railroad ride. Of course there is comfort in safety, but unlike Linus’ security blanket it comes at a price.
Reward is proportional to volatility. Depending on how long you have to invest, volatility like time, can be a necessary ally. Those who choose to avoid volatility entirely will be donating their gains to an institution’s profit. Does 4% on a GIC or investment part of an insurance policy sound good? If the answer to that question is yes, then you won’t mind that the bank or insurance company will take your money and and make double or more for their bottom line.
So how to manage volatility and still sleep at night? To answer that question let’s first introduce the characters who are part of this story. The stock market is a place where shares of companies are bought and sold. Companies must have a certain capitalization size before their shares can be publicly traded. Technology has enabled investors to remotely participate in the stock market. Individuals and institutions trade in the stock market. Buying and selling are influenced by both financial and nonfinancial news.
A mutual fund is an agreement between individual investors and professional money managers about the collective money of those investors. In return for a fee the managers invest on their behalf. Mutual fund managers participate in the stock market.
A bond is a loan to a government or corporation. In return for the use of your money you get paid interest at regular intervals.
The main tools to manage volatility are asset allocation and diversification. Asset allocation is when your portfolio has different investment vehicles such as the aforementioned three, or buying investments that contain those asset classes.
An example of diversification is spreading your investments in different sectors of the economy eg oil and gas or the media. Diversification is also buying into different geographic regions of the world. These are just a few of the ways to diversify your portfolio.
Here is a timely analogy for diversification. It can be compared to a garden. Picture a garden of lettuce only. Let’s say this summer is going to be mostly hot and sunny.Since I know this is Calgary let’s throw in a few hailstorms too. What will this garden grow? A few shredded bitter leaves. Garden number two will have peas, tomatos, potatoes, carrots with the lettuce. Chances are much greater that come harvest time you will be able to throw a veggie party. No matter what the weather you have covered all your bases. It’s the same with investing. High low or flat markets, different investments will perform differently.
The most important point I would like to end with is that in order to be a successful investor you must do the OPPOSITE of what everyone else is doing. In this aspect of your life you have to be unpopular. Is everyone running for the safety of term deposits? Then the best thing to do would be to do what they are not doing.
Til the next time. Question and comments are always welcome.