But you, you shiver in your shoes when your well-diversified 401(k) loses a few percent. How can you get comfortable with the volatility of the market?
1. Get used to it. I predict that markets will be highly volatile, with 100-200 swings in a day. I also remain bullish and expect a bull market for a good many years. But day trading, 24-hour stock markets and changes abroad, such as the EU, will make for constant jitters.
2. Isolate and follow your high-risk investments. It's impossible to keep up with everything. But once you have identified which of your assets are more likely to make big price swings, follow those carefully.
- Track the price "habits" of your stocks. Stocks tend to have a price range, just like clothes and cars. The price range tells you the "support level" (the price below which the stock rarely dips) and the "resistance level" (the price to which it usually rises before it starts to drift down.) These "habits" can be tracked through charts found at numerous financial Websites, such as Morningstar.
- Study the habits of the managers of your mutual funds. If you're in funds or your pension plans only permit funds, take a look at the methods of the fund managers in a jittery market. Read the prospectus and the stories in the financial news. Morningstar reveals the managers' historical performance in a volatile market.
3. Buy at price pullbacks. Once you know the price history of stocks, buy after they reach the support level and start going up. Use a broker's order to put in standing bids at a tick below the support level. Rejoice that you can profit from volatility.
Same holds true for mutual funds. If you identify jittery market winners, load up on them. The best are usually funds that call themselves "value."
4. Bulletproof the remainder of your portfolio. Don't fall in love with risk. Have safety built into the rest of your portfolio. For example, buy bonds, not bond funds, so that if you wait until the maturity date the money will always be there. If you go international, diversify among many countries. And allocate assets just as the planners suggest. Doing so forces you to take profits and reinvest the money in down assets (sell high, buy low).
5. Play with the house's money. Take some of your profits to buy the latest tech or IPO. It's a chance worth taking as long as you're not using the eating money.
|Before you get too crazy over the risk in your portfolio, you should determine whether it's too risky in the first place. Ask yourself: |
1. Do I really own any high-risk investments? "Risk" to you means the likelihood you will lose money. No one knows that, unless they have the mythical crystal ball. "Risk" to a professional means how volatile a stock or mutual fund is in relation to other, similar investments. Luckily, volatility is quantifiable through a formula created by a professor named William Sharpe. The Sharpe ratio divides the annual rate of the fund's return by its standard deviation, which measures how far a fund's rate of return varies from its average return. If you're math-phobic, it's enough to know that the higher the Sharpe ratio, the less risky the fund. You can find ratios at Morningstar for every mutual fund you own.
2. Do I want high-risk, high-reward investments? Now that you know that risk is a code word for volatility, not loss, you may want to increase risk. Why? For the same reason that high-tech can make so much money. If the price swings are large, the gains are, too. And they're fast. You may want the potential to earn 30 to 50 percent. If that appeals to you, remember the down side: you'll have to follow your high-risk investments carefully and be decisive in taking profits and cutting losses.
3. Can I wait out or absorb a loss? Volatile funds and stocks that start out with good fundamentals, good management, low debt, a good marketing idea, a good product and lots of capital usually bounce back after a price drop. It's just a matter of time. But sometimes fundamentals change, and the investment doesn't rebound or takes years to do so. IBM is a case in point.
Many of today's investors can't remember a down market, but if you do, you know the agony of watching cash tied up for decades in losers. Just ask anyone who invested in gold in the past 10 years. If you have enough winners, you'll likely take those losses lightly and use the loss as a tax deduction. But if the loss will ruin your future, you can't play the volatility game.