It seems appropriate this week, given the global issues at play, to address the concept of stock market risk. The financial service industries accepted definition of risk is that of volatility, which is the up and down movements (deviation) from the long-term average. This is sometimes shown as maximum drawdown (biggest drop in value at any single event). Truth be told, this is not risk, risk is permanently losing your money.
The permanent loss of capital can be brought about by three distinct investment mistakes, by understanding and avoiding these mistakes investors can manage their risk.
Overpaying for an investment
Those who bought Di Data shares for R 76 at the height of the internet bubble in 1999 -2000 only to see the share value fall to R 4 will understand this all too well. Calculating the intrinsic value of a business is not easy. However it is not that difficult to spot an expensive asset remembering the old adage of “if you have missed the boat don’t jump in the water” should help avoid overpaying for an investment.
Those who sold shares in 2008 / 2009 when the JSE All Share Index bottomed at 18000 points only to see the index recover to 32000 points less than 2 years later will understand this all too well. Appoint a trusted financial advisor to help you manage your emotions and stick to your investment plans through the cycles.
Investing in a company which goes bust
Those who bought Lehman Brothers shares will attest to this. There is nothing worse than looking for the latest share price only to discover the word suspended. Diversify your company specific risk by holding a portfolio of good businesses in various sectors.
I have had two clients recently refer to the stock market as a casino, which is understandable given the recent fluctuations of shares prices driven by a “risk on / risk off” trading mentality. Investors will do well to remember why they invest in shares and that is to share in the future profits of the companies they have invested in, which has nothing to do with the daily price movements. Benjamin Graham father of value investing and mentor to Warren Buffet said “the stock market is a voting machine in the short-term and a weighing machine in the long-term”. Irrational behaviour affects short-term pricing, but with time rational investors will be rewarded.
Mcomm, CFP®, HdipTax
T. 021-851 3746