Month: April 2014 (Page 4)

There is no doubt that some investors still fear the stock crash of 2008. This is even more common when there are so many discussions about the market being overpriced today. Some advisors are once again suggesting that investors should invest in “safer” businesses.

Much of this fear of a stock crash has more to do with availability bias than anything else. Availability bias is a bias that causes people to overestimate the probability of events that are memorable. Memorable events are further magnified by coverage in the media; therefore, the bias is compounded.

Two prominent examples would be estimations of how likely plane accidents are to occur and how often children are abducted. Both events are quite rare, but the vast majority of people believe that they are more common and worry about them. In reality, people are much more likely to die from an auto accident than a plane accident, and children are more likely to die in an accident than get abducted. The majority of people think the reverse is true. This is because the less likely events are more “available” or more memorable. Looking at the literature or even just the interactions of daily life will reveal thousands of examples of availability bias in action.

So is your fear of another stock crash more to do with availability bias than fact? Are you acting irrationally because of fear that can sometimes be common in the media?

Prudent monitoring of your investments is important. With the strategy that I explain on this site and in my book, The Confident Investor, I teach you to get out of the market before the stock crash is so bad that it destroys your portfolio.  In fact, I specifically do investment trade analysis with the time frame of 2008, just so you know that the system should prevent the worst of dire consequences that occurred during that stock crash (see here, here, and here).

You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.

Photo by zemistor

In general, most of my readers are far too cautious with their investments. They are risk adverse almost to a fault. I see far too many people worried about losing money in their portfolio rather than making money.

Jim Cramer has made a living advising the general public on stock investments. He is not always correct in his predictions but then I don’t know of any prognosticator that is perfect. In this video, he advises that young people in general are too risk adverse. I agree.

In the video above, Jim states that he is 52 and therefore should be more cautious. I tend to disagree, 52 is still not very old. The likelihood of living to 90 if you are already 52 is incredibly high. 52 year old people have a great deal of time to recover from a stock correction and therefore should not be nearly as risk adverse as they tend to be.

So what are the typical actions of a person that is risk adverse? While almost everyone should do some of these listed items, you can go too far especially if these are your top 5 criteria for stock picking decisions.

1. Selling covered calls

If you sometimes sell covered calls on stocks to provide incremental income and limit downside risk then you may be too risk adverse. When you sell a covered call, you are giving the buyer the right to purchase the stock from you for a set period of time at a given price. For example, if you own 100 shares of stock A at $25 and, in October, sell a January covered call with a strike price of $27 at a price of $1, you will receive $100 today. If the share price is below $27 when the call option expires in January, you keep the stock and the $100. If it is above $27, you keep the $100, the call owner buys the stock at $27, and you miss out on some appreciation.

This strategy is inherently a low-risk strategy and therefore great for those that are risk adverse but it also limits your upside potential. Just buy the stock and then actively monitor it with the tools that I teach in my book, The Confident Investor. If you follow my suggestions, you will likely make more money have just as much risk control.

2. Invest primarily in dividend payers

You invest in dividend-paying stocks that provide a stream of income, so that you are not solely reliant on capital appreciation for stock portfolio performance. I have nothing against companies that pay dividends (actually, I do but that is the subject for a different article) but focusing on just those stocks rather than growth companies that need all of that cash to fund their growth is far too conservative for anyone under 60 (or maybe even 70). You have a lot of life to live and now is not the time to be risk adverse. If you want to retire in luxury then you need to not focus just on dividend stocks.

3. Risk adverse people have diversification as the top criteria for stock picks

You diversify, both by company and industry and it is a primary reason to choose a stock. Diversification spreads risk and helps to limit the effect of a disappointing investment on overall portfolio performance, which can help to smooth your portfolio’s performance over time. While diversification is not a bad thing, being too focused on it means you are hurting your overall performance. There are some markets that are simply dogs at any give time, avoid them.

4. Pick defensive stocks

You seek out defensive stocks as a category. Some stocks and some sectors (such as food companies and utilities) tend to be less economically sensitive and therefore to achieve more consistent financial results over time, which can help to reduce portfolio volatility. Their earnings growth may be slower than for more cyclical companies, but it also tends to be steadier, and they generally pay dividends.

As I said above when focusing on diversification, too many companies that are defensive can hurt your portfolio too much. There is a really good reason that my Watch List has so few food companies and utilities!

5. Dollar cost averaging

You probably learned about dollar-cost-averaging for stock purchases if you participated in company stock-purchase programs in which you arranged to buy a set dollar amount of the company stock on a regular basis. The advantage was that you bought more shares for the same amount of money when the price was down and fewer shares when it was up. While this isn’t a terrible strategy, it is very risk adverse. You are probably better served by monitoring the stock as if you are a technical investor and simply buy into the stock when it starts to increase in price. Buying on the way down, simply hurts. It is much more elegant to buy close to the bottom. My book, The Confident Investor, helps to teach you the right time to buy the stock.

Being careful with your money is not a bad thing. However, do not be so risk adverse that you are hurting your financial future. It is key that you understand the workings of the market so that you can make sound decisions. My book, The Confident Investor, will help you with that effort.  You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available paper format as well as in e-book formats for Nook, Kindle, and iPad.

Photo by Garton