Defining Investing Risk
"Take a chance! All life is a chance. The man who goes the furthest is generally the one who is willing to do and dare. The "sure thing" boat never gets far from shore." Dale Carnegie (1888 - 1955)
In 1998 Economics Professor and Nobel Prize winner Paul Samuelson (1915 - ) noted that, "Many people now believe that if they simply hold stocks long enough they will not, lose money for statistics have shown that since 1926 the U.S. equity market has not suffered a loss in any given 15 year."
He called it a fallacy, and conceded that it is truly likely that if you hold stocks over long periods of time that they would tend to produce returns higher than other assets. But to believe that it is a God given statement ... Is simply not correct!
"Risk does not go to zero over long periods," but there are many articles that reflect how risk goes down the longer the time period.
What is seldom introduced is the fact that if there is a significant onetime loss, it can be monumentally overwhelming.
In any case Samuelson noted that: "The problem is that when stock prices do turn down (as inevitably happens even in the strongest of bull markets!) your optimistic equity exposure can overwhelm your gut level risk tolerance, leading to poor short-term judgments and even outright panic!"
Risk is a complex, multidimensional concept that manifests itself in various ways. Risk is omnipresent and includes stock market crashes, corporate bankruptcies, currency devaluations, changes in sentiment, in inflation and interest rates, and even major changes in the tax code.
Risk is generally defined as return volatility, or the degree of ups and downs of returns. But there's more to risk than volatility. Risk and long-term reward are generally related. Risk is the chance that your actual return will be less than you expected.
People sometimes think that a good return can be achieved with little or no risk. Unfortunately, that's impossible. To achieve your objectives, you need to assume certain risks and avoid others.
Your ability to handle risk is related closely to your individual circumstances, including your age, time horizon, liquidity needs, portfolio size, income, investment knowledge, and attitude toward price fluctuations.
What's highly risky to one individual may be no problem to another. Short-term fluctuations are not that relevant for long-term investors who have the discipline, patience, and understanding to deal with them. Stock funds are actually less risky than money market funds for those with long time horizons.
Well-informed investors are far less likely to let risk get the best of them. Those who understand the various elements of risk are better equipped to enjoy a profitable long-term investment journey!
Copyright © 2005 Ioannis - Evangelos (Akis) C. Haramis haramis@greekshares.com http://www.greekshares.com Ioannis - Evangelos (Akis) C. Haramis was born in Athens, Greece in 1951. He studied in Greece, in USA and in Belgium and has been active in the stock markets since 1972. Since 2002 he is New Business Development Managing Director at an Investment Bank and the publisher of http://www.greekshares.com
Making Fortunes With Long-Term Value Investing
The key to making money in the stock market is invest for the long-term, buying only undervalued stocks which, to quote Benjamin Graham, have a "Margin Of Safety". Ben Graham and Warren Buffett both made enormous fortunes through long-term value investing. Indeed, Buffett continues to do so and has averaged over 22% average compounded annual gains over a 39 year period.
These results are phenomenal and not easy to emulate. However, with time on your side and a little bit of work it is possible to do nearly as well as Buffett. Even if you beat the S&P 500's average long term return of around 11%, you are doing very well indeed. Suppose you invest $3,000 in a Roth IRA or other tax-efficient retirement account every year for 20 years and achieve an average annual compounded gain of 11% over that period. At the end of the 20 year period you could have around $238,000 disregarding dealing costs and dividends.
You have only invested $60,000 - so $178,000 is generated entirely through compound interest. If you were to emulate Buffett's 22%, that $60k would become $1,031,000. If you were to start earlier and invest $3,000 a year for 40 years at 11%, you would end up with $2,132,483. Match Buffett's 22% on these investments over 40 years and you may wind up with a whopping $55,000,000, for an investment of $120,000! That is the power of compound interest. Many people ask me "Which stocks do I buy?" and "How do I start?"
They keep making excuses NOT to start investing for the long-term. My advice is a bit like a Nike commercial: JUST DO IT! Get started. Open a Roth IRA, start by putting money in regularly, even if it's only $25/month. It's important to get into the HABIT of regular savings. In the meantime you can worry about which stocks to buy. Picking stocks to buy is not actually that hard. It should not take a great deal of work. There are lots of places you can look for investment ideas: in fact there are hundreds of investing websites, including The Graham Investor where we tend to profile stocks that come up in value-based screens and give an opinion as to why a particular may be worth following - not necessarily buying.
There are many different strategies to take; a typical one is to first screen for stocks that meet a particular value criterion which might be any one of: a low PEG, high intrinsic value when compared to current price, price below two-thirds of the Graham Number. Once we have a list of suitable stocks meeting the basic criterion, we can filter out stocks with poor cash flow, excessive debt, poor earnings, or insignificant anticipated growth. We also avoid stocks with low liquidity by making sure average daily volume is as high as possible, and stocks with low prices (typically steering clear of stocks trading at less than $3). Once the additional criteria are met, look at the charts for each stock.
Look for a recent clear downtrend or new 52-week low. Put the stocks with a most obvious downtrend onto a watch list. In particular watch those where the downtrend also shows declining volume. Look at the news for these stocks to see if there is an obvious reason for their recent poor performance. Do not buy - they could go down more. We don't want to try to catch the bottom; it's a sure way to lose money. What we are watching for is a clear sign of a reversal and buy as the stock moves up. Often a reversal can take place slowly and imperceptibly, other times it can be an abrupt reversal.
Most often it is somewhere in between. Perhaps the stock has been beaten down by investor sentiment in the form of an overreaction to bad news. At some point the bad news may be dispelled or proven to be unfounded, and the stock will begin to return to fair value. Or, some good news may come in and the stock reverses as investor sentiment comes in. Typically when this happens, we want to see the downtrend broken convincingly and the price rising on increasing volume.
How do we know if the downtrend has broken? Simply draw a line joining the high points in the downtrend, and wait for that line to be broken to the upside with significant volume. What is significant volume? It depends. The higher the volume the better. Look for at least 150% of the average daily volume. Once you have bought, set a stop loss order around 8-10% below where you bought. If at all possible, set the stop loss order just below the lowest low point before the reversal, so long as it's not too far away from your entry. Spreading your risk can help minimize losses. Divide your equity into at least 10 lots; if you have $5,000 to invest only buy $500 worth of each stock and keep your stop loss 10% of that, or $50. If the logical stop loss point is too far from your possible entry point, don't invest. Stick to the rules and cut your losses short.
Let your profits run. In the long run you will make much more on the winners than you lose on the losers -- you can have 5 losers and still be down only $250 or 5% of your equity. Buying undervalued stocks with good fundamentals in this way at or near low points when nobody else has been interested for a while but there are signs of a reversal is possibly one of the least risky investment techniques because of the built-in "Margin Of Safety".
(c) 2005 The Graham Investor - Intelligent Value Investing You may use this article, as-is, provided this copyright notice is kept intact
John B. Keown is an IT specialist, website builder and private investor who enjoys all things stock-related and in particular seeking out undervalued stocks. He can be contacted via The Graham Investor - Intelligent Value Investing
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