When you think of investment risk, what comes to your mind first? Many people think, “I could lose all of my money!” If you’re invested in something like a diversified stock mutual fund, the chance of losing all of your money is very unlikely. However, there is definitely a risk of volatility, which can turn into a partial permanent loss if you sell out after a downturn in price. Did you notice that I said “price,” not value? Many investors confuse these two without even realizing it.
I remember a conversation I had with a money manager whom we were evaluating for potential use in our portfolios. I asked her what kind of risk controls they had in place, in the event the price of a particular stock they owned started to go down. She asked me if I meant if the stock went down in “price” or “value”? She said if it was just the price that changed, she would consider if it was a good time to buy more. If it went down due to the value of the company dropping because of a specific company issue, she would have a very different thought process as to keeping it or buying more. I confessed to her that I said “price,” but I meant “value.”
It is very easy to get caught up in the “excitement” of the live auction that we call the New York Stock Exchange to the point that we forget it is an auction. I have attended a number of auctions over the years, so I understand how easy it is to get caught up in the commotion and excitement and end up paying more than you should for the item being auctioned. The same feeling can overwhelm you regarding the stock market. We get excited when prices are on the way up and jump on the bandwagon and buy some stock, even though it is overpriced. The same bandwagon can appeal to your fear of permanent loss and cause you to jump off the wagon on the way down, which makes the loss a self-fulfilling prophecy. Emotions have a strong influence on our lives.
I have told my radio listeners, seminar attendees, and clients two of my philosophies that I think help keep them from making the wrong moves at the wrong time. First, be sure to keep some of your money in things like money market funds, CDs, and/or U.S. Treasuries. Even though these investments don’t earn as much over time, they do help keep you from bailing out at the wrong time.
Second, if you are the type of person who will bail out when your growth investment goes down 5%, 10%, or 20% (pick your number), then please don’t invest in those types of investments. History tells us that those types of investments WILL go down, but history also shows us that the price will go back up to a point higher than it was before it started going down.