When I first joined Wachovia in 2008 (you may know us as Wells Fargo), one of the first things I was told was, “Sometimes you buy stocks when they are down so you won’t get tempted to buy them when they go up.” I felt it was great advice; it tells us there are subtle risks in stocks that are just as real as the obvious ones.
Academics define risk in terms of volatility. Most of the investors I know do not worry that the stocks they own will go up too quickly--that would be a wonderful feeling! They worry that what they own will go down in price and that they will lose money--pretty normal if you ask me. Losing money is painful. It’s only right that we all want to avoid doing it. That being said, risk shouldn’t always be avoided at all costs.
Overtime, we have been shown that stocks seem to defy the rules of supply and demand. In most cases, higher prices mean less demand and lower prices mean more demand. This is not always true in the capital markets. Sometimes when an asset appreciates, there is a belief in further appreciate of that asset in those who have not participated in the rise; those who have not bought in experience remorse. The feeling can exist even more if that rising asset was avoided because of fears of losing money. In addition, an alternative asset was purchased as a result of expected lower risk when, unfortunately, little or no return was given to its holder, causing even more remorse.
It can be painful not to own stocks as they are going up. Investors feel they have “missed the boat,” which can cause one to enter the market at higher prices and set the stage for future losses. Investors should be risk averse, but they should also be aware of the bucket of risks that exist.
The future is risky by nature. One cannot avoid risk, but one can manage it. A diversified portfolio may mean that you are never entirely right, but guess what? The chances of you being entirelywrong are small. When was the last time you rode on a Ferris wheel. It would be stupid to investall of your assets in one bucket. What would be smart is to divide those assets into several buckets in that Ferris wheel. Should one bucket tip, you have others to stabilize that one bucket’s loss. 100% cash portfolio can cause almost as much trouble as one that is 100% common stocks.
There is still room for appreciation. The world is still far from perfect. The perceived risks of stock prices are still widely felt. Is the least understood risk the risk of no equity exposure at all?