Investing Rules from an Old Guy

Rule #11

High risk, high returns.

What is risk? It actually means different things to different people, and I’ll spare you a discussion of the statistical measurement of risk called the standard deviation and a related metric called beta β (Google it to learn more if you want), but for most people it has to do with volatility. Psychologically, losing feels 10x worse than winning so you can think of risk as the anxiety you feel when your investments are down and declining.

Before you get started or soon after you start investing, you need to figure out how much risk you can tolerate. If the market drops 20% or 30% are you going to panic sell or hold your positions? Note that the absolute worst time to sell is when the market is in a steep decline. The market ALWAYS recovers and proceeds to new highs. Trying to time the bottom of a dip is the #1 mistake individual investors make.

In terms of risk, I would rank the various vehicles as follows:

• Cash, Checking accounts
• Savings accounts, Certificates of Deposit (CDs)
• Money-Market Funds
• Bond Index Funds/ETFs
• Bond Mutual Funds
• Stock Index Funds/ETFs
• Real Estate Investment Trusts (REITs)
• Stock Mutual Funds
• Individual Bonds
• Individual Stocks

Every time period will be different, so the chart below for 2019 graphically shows risk vs actual returns plotted for 2019 when the S&P500 returned an incredible 28%. If your stock portfolio when plotted on a chart like this falls on or above the yellow line, you are doing AWESOME! Even if you fall below but near the yellow line, consider yourself VERY successful.

While the benchmark is the S&P500 when ignoring risk, the target benchmark for a stock portfolio is the yellow line which takes into account the fact that less risky stocks are not going to do as well relative to more risky investments. [Note: I got this chart from Schwab. You can get to it through the menus path: Accounts>Portfolio Performance>Rate of Return>Risk & Return. Let me know if you find other ways to get this.]

At this point you might be thinking the 1 ETF Portfolio which tracks the S&P500 is looking like the way to go, which is true in good years like 2019. Let’s look at a similar chart for 1Q 2020 when the S&P 500 dropped a crazy 24%.

As you can see in the 2 preceding charts, within a short span of 12 months, the 1 ETF Portfolio gained 28% only to then drop 24% just 3 months later! If you can tolerate this kind of volatility, the 1 ETF Portfolio could be for you.