Bellmore Group Management Services, Tokyo Japan 3 Risks of Investing in the Stock Market

Bellmore Group Management Services, Tokyo Japan’s 3 Risks of Investing
in the Stock Market
Risk 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:
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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:
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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: