All good things, as they say, must come to an end. After a dozen years or so of contributing to Nasdaq.com, this will be my last week of daily musings. From my perspective, it has been a fun experience for the most part. After all, I get to give my opinion on the markets on a regular basis, something that anyone who has ever met me will know I am happy to do in any context. My hope, though, is that it has also been fun for you, the reader, and at least somewhat informative and helpful. That desire to be helpful led me to conclude that I would, in this last week, revisit some of the themes that I think are the most important things for retail traders and investors to understand.
Looking back through the 266 pages of archived material, one of my earliest pieces, written in early July of 2012 and titled “Reassessing Risk,” stands out. It was an article prompted by my time as a financial advisor, where we were trained to equate risk with volatility. Most people who have met with an advisor will be familiar with the chart that plots “risk” against return, with the idea being to maximize return while minimizing risk.
That is obviously an admirable, if somewhat contradictory goal given that in investing, return is your reward for taking on risk, but the way it is usually portrayed starts with a fundamentally incorrect assumption.
Volatility and risk are not the same thing.
The two examples I used back then were US Treasuries and Micron Technologies stock (MU). Treasuries are the “risk free” asset for investors, based on the fact that they are backed by the “full faith and credit” of the US government, while at that time MU had been extremely volatile, with intraday moves of 5% or more quite common, and big longer-term swings in the stock being a regular thing.
My point was that with MU at the bottom of a long-term range as it was then, and Treasury yields at historic lows (which means prices at historic highs), the risk for long-term investors was much greater if buying Treasuries than if buying Micron. Not to brag, but the results of both securities since kind of prove my point:
If you had bought TLT, the ETF that tracks long-term Treasuries, on the day that article was published, you would currently be showing a loss of 28% on that “safe” investment, as opposed to a profit of 2,147% had you put that money into MU instead.
While this looks like an extreme, cherry-picked example, keep in mind that when I wrote the piece in 2012, I didn’t know what the future would hold. What I did know, though, was that buying Treasuries, which, from record or near record highs, had an upside limited by the fact that negative yields were unlikely and unsustainable should we get to that point and a significant downside based on a simple reversion to the mean, was far riskier than buying stock in a well-run, financially stable company that was at the bottom of its long-term range.
In that situation, the volatility that financial advisors warned you to be so scared of actually worked in your favor, because volatility is a two-way street. The word describes something that moves around dramatically, but that movement is not just downwards. Risk, on the other hand, is about the possibility of losing money on an investment, and the chances of that were far higher in 2012 if you bought Treasuries than if you bought MU. The subsequent performance differential is extreme, as I said, but it was actually pretty predictable that MU would outperform TLT over periods measure in years.
The idea of questioning the conventional wisdom of investing is something that has come up quite a lot over the last 12 years, and it is an important one. I am not saying that you shouldn’t take such advice, but that you should understand that such advice is either based on the desire of those giving it to make money for themselves, or is based on theories formulated decades ago, and which maybe don’t apply to the modern world. So, educate yourself and question everything, but most of all, learn to understand and embrace risk.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.