One Egg, One Basket
Day 24. How to handle stock market risk
“More Americans Than Ever Own Stocks” was a December 2023 headline in the Wall Street Journal. Is it a big deal to have some savings in stocks? Yes. Performance history makes a compelling argument. If you save anything, join the other 58% of families who held stock as of year-end 2022.
Even if it is pennies and you really worry about risk.
Easy for me to write. You might think, “B-school, ivory tower guy has no idea what risk is like in the real world.” That is partly true.
We share a lot in common because investing is personal and human.
For many potential investors, the thought of a stock investment is better repressed. Why take the risk and invest in stocks when money can be lost? That would be major league psychic pain to go along with the financial hurt.
And then there is FOMO. FOMO is always in play because we are a greedy lot, and the pain of missing the next upward move by Nvidia may lead to unnecessary risk-taking.
A deep breath and a pause in making an investment decision until tomorrow help stave off bad choices, including the choice to do nothing.
Knowing a few principles can help.
One Egg, One Basket: How to Manage Stock Market Risk
Savings in one investment exposes you to its individual risk. If you have 100 eggs, don’t put them in a single basket.
Pro Tip: Put a single egg in a single basket. Allocating the same amount of savings across multiple investments, aka you create an investment portfolio, gives a beautiful result: a portfolio's risk is less than the weighted average of the risks of the individual investments. You don’t need to know the math to have it work on your behalf.
Buy pre-built portfolios. Mutual and exchange-traded funds are groups of investments assembled by humans or computers. Today, we focus on stock market risk, and stock mutual funds represent assemblies of stock investments. But bond mutual funds and money market mutual funds exist, too.
Totally discount unreliable ideas about investing in publicly traded stocks. Tips, investment fads, CNBC talking heads, etc., will not give you inside information that raises your chances of a return better than what you can expect for the risk.
Pro Tip: Rely on your brain! If you have specific information that affects the future economics of a publicly traded company, do you think you are the only investor who knows?
Wealth diversification is usually in play. Working, Social Security retirement benefits, and the mobility to move to lower-cost regions are factors that help manage investment risk.
Pro Tip: Know wealth diversification. Even the best available investment risk diversification raises and lowers your living standard, but not as much as you feel when you think in wealth diversification terms. Households have built-in hedges for investment risk.
Unlikely is the event that your stock portfolio goes to $0 + you lose your job forever + social benefits go away, + every feasible geographical area has the same unbearingly high cost of living.