Friday, February 21, 2014

the risk of stocks

Retired investors seeking high income to live off of during retirement face greater challenges today than almost ever before. The days of high yields available from bonds and other fixed income vehicles are long gone. Consequently, generating an adequate level of current income on retirement portfolios is difficult to say the least. This is especially tricky for those investors with a low tolerance for risk.

Moreover, there’s no question that equity investments technically carry more risk than fixed income investments. This is widely acknowledged, and in the general sense, an unarguable position. However, this begs the question as to exactly how much more risk do equity investments carry versus fixed income investments? In other words, is the risk of investing in equities (common stocks) versus a fixed income instrument (bonds, CDs, etc.) 100% more risky, 50% more risky, 25% more risky, 10% more risky, etc?

These seem like important questions to ask and have answered. However, I have personally not come across any truly cogent analysis that precisely quantifies the greater risk of a stock or equity over a bond or other fixed income instruments. But with this said, my more than 40 years of experience investing in equities lead me to conclude that most people overestimate the greater level of risk that equities possess. This is especially true regarding equities with long histories of paying dividends. Yes, I agree that there is greater risk, but I do not agree that the risk of owning equities is as great as many people contend or believe.

... when evaluating the risk of investing in stocks, many investors are referencing price volatility. And usually, by volatility they mean the risk of the price of the stock dropping. However, I contend that if the price of a high-quality company does drop, but the underlying fundamentals of the business remain strong, that it represents opportunity rather than risk. About a year ago I wrote extensively on the subject found here.

Additionally, I also authored a two-part series on how investors can mitigate the investment risk associated with owning stocks. In part 1 I elaborated more on the concept of volatility risk.

Then, in part 2 I expanded my discussion on risk to include numerous other risks associated with investing in common stocks.

And, for those interested in learning more about the volatility aspect of risk, I authored another article in April 2012.

The primary point I expressed in this last article is my contention that it is not the volatility itself that establishes the risk of owning a stock; rather the greater risk rests in how people react to that volatility. The following excerpts from a comment shared by a regular reader of mine on my most recent article nicely summarizes this point.

My objective is to earn an income stream that is reliable, predictable and increasing. It's all about the income stream, what I refer to as my pension from Mr. Market. I need to know what that pension is going to pay me in the distribution phase of my life. I can do that with dividend growth investing…

This year has seen the market correct to where it is down for the year. The Dow was down over 5% in January alone. Although the market continues to fall, my pension payment continues to rise. I will establish an all-time high in dividend income this month, and it has nothing to do with share prices. Market falls, I get a pay raise…

-- Chuck Carnevale

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