Some musings on risk.
I've been buying stocks for about 1 1/2 years now, and have done a lot of thinking about risk. It's a word that comes up in almost every post. However, there isn't any clear definition that everyone agreas to. From the context, it's apparent that investors mean very different things when they use the word.
The various definitions, I think, can be grouped into two general catagories:
1. Risk equals short-term volatility. This risk can be roughly quantified by looking at the 12-month price range, as a percent of the current or average price. By this definition, AMAT is a very risky stock. The risk to your capital, over a 3 to 12 month time frame, is quite high. When suggesting AMAT to other investors, they are initially enthusiastic, when I describe the fundamentals. Then they look at the stock chart over the last couple of years, and get scared. They say things like, "This is my retirement money, and I've got to keep it safe.I'll put the money in bonds, and maybe buy a little bit of AMAT, with money I can afford to lose."
2. Risk equals the long-term chance of making less than the return from a risk-free investment (like quality bonds). This risk is harder to quantify. It involves looking farther into the future. Most people think it is impossible to predict anything 3 to 10 years into the future. Therefore, they attempt to predict just the next 3-12 months, and trade stocks accordingly.
Stock prices, over the short term, are determined by people who have an outlook of only 3-12 months, or less. These decisions are essentially emotional. They are also essentially unpredictable.
Technical analysis attempts to find patterns in these short-term movements. I haven't had much success with this. My attempts at short-term timing have about balanced out, with a mediocre return. I'll keep studying.
It's odd, but with some companies, I think it's easier to predict 5 years than 5 months into the future. If they have a consistent track record over the last 5 years, and if there is no reason to think that pattern won't continue over the next 5 years, then it's a safe bet. Safe, that is, using the second definition only. This only works if the company has a track record, if no fundamental change happens in the market, industry, or company. Lots of ifs. It also only works if an investor can ignore the words and actions of everyone whose outlook is less than 3-5 years. That means you have to ignore 98% of available information. It also means you have to buy stocks based on what you think, not what the market thinks. You have to have the courage to say: "I'm right and the market is wrong, and I'm going to put my retirement money behind that decision and let it ride." One implication of this is that the efficient market theory is wrong in the short-term, but right in the long-term.
Few people have the self-confidence to do this. People want the approval and agreament of their peers. It is emotionally very difficult to buy a stock when noone else is, and when everything you read in the financial press is negative. If you make a decision in isolation, and it goes bad, then you failed. If you make a decision as a group, and it goes bad, then you didn't fail. The group failed, and you don't have to feel bad about it. Of course, the truth is, either way you lost money. But it feels a lot better to fail with the crowd. After a few lonely failures, people get timid and say, "I won't buy unless the expert (broker, analyst, mutual fund manager, the most frequent poster on an SI thread, my dad, a CNBC commentator, take your pick) says to buy. Then it's their fault if it goes down." I have clicked through hundreds of SI posts which are variations on this theme.
I saw an interesting chart recently; I forget where. A graph of the S&P 500 over the last 20 years was put together with a chart showing average flows into stock mutual funds for the same period. The times when flows of new money was at a low point were: 1982, 1987(after the crash), 1990, 1994. In retrospect, these times were also precisely the best time to put new money in. The reasons why people didn't put much money in then (recession, rising interest rates, a recent market decline), turned out to be ephemeral. The crowd, and the experts, were consistently wrong.
My entire portfolio consists of AMAT, CSCO, SEG, and WPI. Each of these was bought when it was out of favor. All of them, (with the exception of SEG, which I just added), has gone up far more than the S&P while I've held it. So far,my long-term decisions have been consistently excellent, although I'll be a lot more certain of that statement if my above-average returns survive the test of the next recession. I'm thinking of adding more AMAT, although it's already my largest holding. I'm also going to add ANDW, and BSX (once it finds a floor). I can't find any other stocks worth buying.
Any other suggestions of risk-free stocks to add to my portfolio? |
