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3 Risks of Investing in the Stock Market – Volatility, Timing & Overconfidence

dice invest-918x516Risk and reward are inextricably intertwined, and therefore, risk is inherent in all financial instruments. As a consequence, wise investors seek to minimize risk as much as possible without diluting the potential rewards. Warren Buffett, a recognized stock market investor, reportedly explained his investment philosophy to a group of Wharton Business School students in 2003: “I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out.”
 
Reducing all of the variables affecting a stock investment is difficult, especially the following hidden risks.

1. Volatility

Sometimes called “market risk” or “involuntary risk,” volatility refers to fluctuations in price of a security or portfolio over a year period. All securities are subject to market risks that include events beyond an investor’s control. These events affect the overall market, not just a single company or industry.
 
They include the following:
 
Geopolitical Events. World economies are connected in a global world, so a recession in China can have dire effects on the economy of the United States. The withdrawal of Great Britain from the European Union or a repudiation of NAFTA by a new U.S. Administration could ignite a trade war among countries with devastating effects on individual economies around the globe.
Economic Events. Monetary policies, unforeseen regulations or deregulation, tax revisions, changes in interest rates, or weather affect the gross domestic product (GDP) of countries, as well as the relations between countries. Businesses and industries are also affected.
Inflation. Also called “purchasing power risk,” the future value of assets or income may be reduced due to rising costs of goods and services or deliberate government action. Effectively, each unit of currency – $1 in the U.S. – buys less as time passes.
 
Volatility does not indicate the direction of a price move (up or down), just the range of price fluctuations over the period. It is expressed as “beta” and is intended to reflect the correlation between a security’s price and the market as a whole, usually the S&P 500:
 

  • A beta of 1 (low volatility) suggests a stock’s price will move in concert with the market. For example, if the S&P 500 moves 10%, the stock will move 10%.
  • Betas less than 1 (very low volatility) means that the security price fluctuates less than the market – a beta of 0.5 suggests that a 10% move in the market will produce only a 5% move in the security price.
  • A beta greater than 1 (high volatility) means the stock is more volatile than the market as a whole. Theoretically, a security with a beta of 1.3 would be 30% more volatile than the market.

 
According to Ted Noon, senior vice president of Acadian Asset Management, implementing low-volatility strategies – for example, choosing investments with low beta – can retain full exposure to equity markets while avoiding painful downside outcomes. However, Joseph Flaherty, chief investment-risk officer of MFS Investment Management, cautions that reducing risk is “less about concentrating on low volatility and more about avoiding high volatility.”

Strategies to Manage Volatility

Strategies to reduce the impact of volatility include:
 
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How to Live Off the Grid

off-grid-log-cabin-918x516Open frontiers, freedom to live one’s life without restrictions, and the romance of living in harmony with nature have long been part of the American psyche. Authors and filmmakers have captured the desire to live independently and rely solely on one’s abilities for centuries.For example:
 

Henry David Thoreau

Thoreau, a 19th century poet, writer, and naturalist, explained the fascination with a simple life in his 1854 book “Walden“: “I went to the woods because I wished to live deliberately, to front only the essential facts of life, and see if I could not learn what it had to teach, and not, when I came to die, discover that I had not lived.”

Ayn Rand

The Russian-born American author, writing “Atlas Shrugged” a century later, detailed the success of a community of industrialists and inventors who rejected the strictures of society to build Galt’s Gulch, a hidden community in the wilds of Colorado with little law and where everyone worked.

Ned Buntline and Prentiss Ingraham

The pair, best known of the dime novel authors, wrote fictional stories that focused on the frontier with fictional accounts of strong, self-reliant Western heroes from Daniel Boone to Wyatt Earp, finding huge audiences between 1860 to 1920.

Lee Child

The pseudonym of author Jim Grant is best known for his more than 20 novels featuring his nomadic Jack Reacher character. Reacher, a retired military policeman, travels the United States by walking or traveling by bus. He stays in cheap motels using made-up aliases, has no possessions other than the clothes on his back, and eschews such modern conveniences as credit cards, cell phones, and computers.
 
The idea of escaping societal obligations has appealed to certain Americans since our country’s formation. Many historians characterize the Plymouth Colony, established in 1620, as the nation’s first commune, its founders leaving England’s restrictive laws to create a community in the wilderness on a new continent an ocean away. The colony initially depended on upon collectivism, and each individual’s sense of personal responsibility to sustain the colony.
 
Much more recently, Peter Thiel, co-founder of PayPal, has proposed a new nation-state composed of banded-together platforms floating in the ocean 200 miles from San Francisco. Known as Libertarian Island, the community would have “no welfare, loose building codes, no minimum wage, and few restrictions on weapons.”

The Meaning of “Living Off the Grid”

The term “living off the grid” appeared in the mid-1990s and is credited to environmentalist Nick Rosen, founder of Off-Grid.net. Some define off-grid as being independent of electrical utilities and having a smaller carbon footprint (“going green”). Some claim it to be a self-imposed exile from the modern world and its conveniences (“dropping out”), while others define it as being anonymous (“being untraceable”). Andrew McKay, a journalist with Survival Mastery, calls it “living without any dependence on the government, society, and its products.”
 
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Is an Extended Warranty the Cost?

extended-warranty-918x516
“Would you like the AppleCare Protection Plan for your computer?” asked the salesman. I had just purchased a new 27-inch iMac at my local Apple store. The plan, available for $169, would extend the manufacturer’s warranty from one to three years and would include technical support, as needed. The cost seemed reasonable, especially since I was spending more than $2,000 for the iMac. I had to ask myself, “Will I need the extra protection?”

How Extended Warranties Work

An extended warranty is an agreement or contract to repair, replace, or maintain an identified vehicle, residential or other property due to operational or structural failure from a defect in materials, workmanship, and, in some cases, normal wear and tear. It is generally sold as an add-on product, and covers a specific duration of time in return for the premium paid. Extended warranties sometimes offer additional service options or more flexible terms than the manufacturer’s original warranty.
 
While appearing to be a type of insurance, the National Association of Insurance Commissioners ruled in 1995 that extended warranties were not insurance, but extended service contracts. While the extended warranty industry has been regulated by various state insurance boards, the Consumer Financial Protection Bureau (established under the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010) is expected by many in the industry to replace the various state regulators for a more consistent approach.

Parties to an Extended Warranty Contract

The sale and administration of an extended warranty or service contract requires a combination of separate functions, although a single entity may perform several in some cases. Parties include:

  • Purchaser/Owner. The person or entity who purchases the extended warranty and is entitled to its benefits, subject to contractual conditions.
  • Principal/Obligor. The entity that assumes the risk in the contract and is financially responsible for the costs of repair, replacement, or maintenance. Some principals self-insure (keep the risk), while others purchase third-party insurance to reduce a portion (or all) of the risk.

    • <;i>Service Contract Provider. The entity that actually delivers the warranty services – i.e., repair or replacement of the damaged product – to the purchaser of the extended warranty. This can be an unrelated third-party, manufacturer, distributor, or retailer of the product.

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5 Keys to Better Enjoy the Holiday Season With Your Family

family-christmas-reading-story-tradition-918x516If your holidays and family gatherings are stressful and often disappointing, it is time to try something new. Using the holidays to confront family members in yet another annual sparring match is a certain recipe for a ruined celebration.
 
Instead, look at the holiday season as an opportunity to make peace with estranged family members, experiment with low-stress celebrations, and put yourself and those you care most about first. Try employing the following tips to help you reduce stress and enjoy the festivities more than you have in years past.

How to Better Enjoy the Holidays

1. Establish Your Priorities

Trying to satisfy the expectations of parents, siblings, or children during the holidays can overwhelm anybody. Selecting gifts, decorating, preparing food, and planning travel are physically and emotionally exhausting. Often, when the family gets together, members are expected to conform to their old roles based on birth order, gender, family rules, and rituals, ensuring that the holidays are “like they are supposed to be.”
 
According to Dr. Ken Duckworth, medical director of the National Alliance on Mental Illness, “We tend to compare ourselves with these idealized notions of perfect families and perfect holidays.” As a consequence, the pressure to go along, rather than rock the boat, triggers resentment and conflict.
 
When your holidays become a time of guilt, anger, and regret, it is time to change the dynamics. Neither you nor your family are the same people who established your early roles and traditions.
 
Changes are inevitable in every family. Children grow up and become parents. Healthy, independent people age and become dependent. Siblings move across the country, pursue different careers, and develop different values. These changes require a new perspective and the evolution or replacement of the rituals and relationships that may have been satisfying in the past but are no longer appropriate.
 
The first step to a happy holiday is to determine what you want from the experience. What is important to you? What are your priorities for the season? Give up on the idea of a perfect family, perfect environment, and perfect gifts. These goals depend upon others whom you cannot control.
 
Consider what you want from the holidays, not what others want from you. Which traditions are important to you, which traditions should be changed, and which traditions should be discarded? Recognize the changes that have occurred in your life and other family members, and adjust your expectations accordingly.

2. Plan Your Activities

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