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Reducing Your Risk With Stock Investments
With all the hullabaloo about speculation, an amateur investor can assume that Wall Street is strictly for gamblers. A long-term investor can get better results in the stock market than elsewhere, provided you follow a few fairly simple rules.
Risk in Perspective
Compare owning stock with driving a car. Every year cars, trucks, and their drivers cause a fantastic number of deaths and personal injuries, not to mention property damage. The great majority of drivers are careful at least nearly all of the time. Most accidents are caused by a comparatively small number of careless and reckless drivers.
A cautious person, knowing that he or his family may be the victims of the next accident, could conceivably protect himself by refusing to use highways, the riskiest roads. But we continue to drive and we mentally deal with the risk.
On Wall Street, speculators, despite the commotion they raise, are only a small minority, like reckless drivers on highways. And in contrast to the highway problem, a cautious amateur can invest in such a manner that he runs little risk of having his finances wrecked by gamblers.
Traditionally, owning a business involves serious risk, sometimes complete failure. An investor, knowing the instances of bad results in small business ventures, may assume that in buying corporate stock he must expect to run somewhat comparable risks, and so he makes no attempt to learn how to reduce the danger. Apparently a great many shareholders have attitudes more or less like this. They may not want to gamble, but they don’t bother to learn whether it can be avoided.
How to Reduce Risks of Stock Investing
An amateur, wanting to avoid gambling in stock, must do some studying. The main ideas for lowering risks are:
- Avoid egotism. Realize that there are several million stockholders in this country. Admit to yourself that probably a lot of these people are just as smart as you are. Be satisfied with results a little better than average.
- Avoid prophets, especially the positive ones. The stock market reflects events and rumors from all over the world, and no one or any group of people can be sure of what is going to happen, or when.
- Do not borrow on stock. The price could drop and wipe you out.
- Diversify. Don’t put all of your capital into one investment, or into just one type. Put part of your savings into common stock, the other part into fixed-price items cashable at any time without loss of dollar value.
Own stock in a good many corporations. The larger the number, the better the chance of getting average results. For real diversification, the companies should be in several different industries. For instance, pick an oil refiner, a utility, a financial services company, an electronics manufacturer, a railroad, a retailer, and so on. - Check the stock’s marketability. Before you buy, make sure that you can sell or redeem it easily and promptly.
- Choose skilled management. Find out how to pick a manager of proven competence.
- Adopt rules on timing of your buying and selling stock. Timing of buying and selling is a major risk in owning stock. After you buy, the price might drop; after you sell, perhaps the price rises. Maintain a standard ratio between the current market value of your stock and your reserve. Also, buy and sell stock only in small installments, never moving a large portion of your capital within a short time. By spreading installments over many years, you obtain a fair average price per share.
- Review periodically. Don’t put stock away and forget it. At regular intervals, check back to see how well your stock has performed during the past five or ten years in comparison to other stock you might buy.
Your reaction to these ways of reducing risk may be: “Those are nice ideas for an investor with considerable capital, but they are impractical with only small savings. Trading fees are a high percentage on a small transaction, so a small investor cannot afford to make a large number of small purchases and sales. Also, the fee for first-class advice is too high for an ordinary investor to pay.”
This complaint is valid, provided the investor insists on owning stock in the customary old way — that is, being a direct owner of stock in corporations. But mutual funds, the open-end type of investment companies, make it quite practical for an investor with only small savings to use every one of the ideas listed above for lowering the risks of owning stock. This statement is be expanded throughout this site.