Most of the money I have invested is in growth stocks, even though the “rule of thumb” for someone my age would be to have about 35-45% of my money in bonds. Doing so helps smooth out the bumps in your portfolio since bonds tend to hold up in price better than stocks, except when interest rates rise. In fact, a portfolio consisting of about 40% bonds and 60% stocks is considered the minimum risk portfolio since it will have the least amount of volatility (a measure of the rate of change in price), yet having such a portfolio will provide a long-term return of only about 1% less that one consisting of 100% stocks.
Yet I keep about 100% stocks because I don’t want to give up that 1%. I’m perfectly happy to have 40% drops in the value of my holdings every ten to twenty years or so to get an extra percent. It doesn’t seem like much, but over 40 years 1% can add up to a lot of money. Why leave this money on the table ? I know that all I need to do when the market falls is wait it out, because usually in a year or so the market will have recovered. In really bad times, it might be five or even ten years before it gets all of the way back up. If you were into the NASDAQ in 1999, it was ten to fifteen years before the market fully recovered and reached old highs. I just keep waiting, and buying more all along so that I don’t just lose those years, and don’t worry about the value of my portfolio.
You can do that with stocks because stocks have a natural tendency to increase in value. More people are born, buying more things. Companies get better at what they do and crank out products more efficiently. Even the value of the dollar sinks a bit, causing more dollars to be needed to buy the same shares of stock. The stock market is like a wild river, always flowing downstream, but with a few eddies, rapids, and deep, slow sections along the way. This means that I can pretty much guarantee a positive return in the 8-20% annualized range if I am willing to wait long enough. You don’t drop a boat in a river and then expect to find it upstream an hour later.
But this does not mean that all investments (a word used loosely here) are like this. For example, you have absolutely no guarantee that you’ll make money trading options, even if you do it for a really long time. The reason is that you have a limited amount of time before the option expire at which time you will either make money or not. The same goes for day trading. The same goes as well for playing roulette or the lottery. In these cases there is no natural upward drift in value. At best your odds are 50-50 that you’ll make money – most of the time they are less. When they are less than 50-50, such as in roulette where there are two house numbers, putting the odds a little in the favor of the house if you’re betting red and black, if you keep playing or speculating there is a guarantee that you will lose money over time.
So don’t forget to factor time into your considerations when looking at risk and volatility, but also make sure that time is on your side when you invest.
Got a question about personal finance or investing? Please leave a comment.
Follow on Twitter to get news about new articles. @SmallIvy_SI
Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.