We talk a lot of about stock investing in the personal finance community, its upsides as well as the risks involved. It’s often seen as a way of multiplying wealth with money and creating passive income for future retirement. And it is, but we must talk about the downsides as well.
How much risk can you actually take?
So you opened your brokerage account and started buying shares of stock in several companies. In an ideal bull market, you will make back your money and more in a few weeks or months, or even within the day! They say that everybody is stock guru in a bull market. Suddenly people are day-trading, quitting their full-time jobs to chase gains in the stock market.
In the beginning of this market downtrend, everyone on my social media was suddenly a financial analyst, optimistically saying that dowturns are a buyer’s market and an opportunity for you to buy more stocks on the downtrend. Right now, with a recession in close proximity, I do not hear anymore from these former bandwagon analysts.
Indeed, as long as the company remains viable and you don’t need your money in the next five to ten years, market dips may be an opportunity to buy more shares in such company. They say individual stock-buying is risky and in this way, it is.
With the dip in the stock index and overall price in shares, timing the market will be difficult.* So will the bygone days of making 50 to 100% profit in three months. So you do cost-averaging and steadily invest little by little every month, whether the price rises or falls. At the end of the year, this may result in a further loss as we approach a global recession. In dollar/peso terms, how much risk can you actually take?
Can you take losing PhP120,000.00/USD2,300.00?
At my portfolio’s worst, this was the paper loss that I sustained. Companies sometimes endure a year of a billion peso loss, hence the substantial price drop. The company, however, remained financially viable so we decided to stay put. It was certainly scary and ominous of a gloomy market. Should we sell, should we hold?
The numbers mean differently though when you look at the big picture. Interestingly, the PhP120k was only a -12% loss in our overall stock portfolio as our other shares were in the green. Being way below the 50% threshold, we decided to stay put.
If we had an urgent need of the money, our options would have been limited. We would have been constrained to SELL at a LOSS and liquidate so we can use the money.
Essentially, this is what it means to take RISK in the stock market. In the worst case scenario where the company becomes insolvent** you may be forced to sell just to recoup at least some amount of money back. So invest only money you can afford to LOSE. Don’t put all your eggs in equities, particularly when buying individual stocks where risk isn’t a adequately distributed as opposed to buying a mutual fund invested in probably more than a dozen companies.
How to mitigate risk
In order to mitigate risk, a fairly liquid emergency fund of six to 12 months would be ideal. If a major purchase is within your horizon, then don’t put the money for that planned purchase in the stock market, unless you want to lose it.
How much risk can you TAKE?
*And I don’t time the market.
**Philippine laws do not employ the term “bankrupt.”