What Most Investors Get Wrong About Risk
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As much as I love the stock market, it sure can be a strange place. It's one of the only places I can think of where people become less interested in something when it gets cheaper.
In almost any other setting, a lower price makes something more attractive—whether it’s a car, a house, or 2-for-1 margaritas at Juan's Flamin' Fajitas. But when it comes to stocks, lower share prices tend to scare people away rather than reel them in.
We’re getting a front-row seat to this right now. With the S&P down over 5% year-to-date, investors are understandably feeling nervous, and I've been getting a lot of questions recently from people wondering whether they should sell their stocks until things calm down. I know a few investors who actually have.
Reactions like this usually come from misunderstanding two critical (and ever-present) concepts in investing: risk and volatility. Many investors mistakenly think these two are the same, but in reality, they’re quite different.
Volatility simply measures how much and how fast a stock’s share price fluctuates—and right now, volatility is higher than Snoop Dogg on top of the Stratosphere.
Risk, on the other hand, measures the likelihood of permanent loss of capital. This has more to do with the underlying fundamentals of the business rather than just the stock’s share price movement.
Like I said, these are two very different things. And while risk is something to be careful with, volatility can be used to your advantage.
We covered this in last week’s newsletter, but if a stock’s share price is seeing dramatic swings, it can create buying opportunities. And if the price goes down, that doesn’t necessarily make it riskier. If anything, it can make it less risky because a lower price provides a higher margin of safety.
All of this reminds me of something I recently read about in Warren Buffett's 1993 letter to shareholders. In it, he wrote that the real risk in investing isn’t volatility or short-term share price swings. Instead, the biggest risk is whether your investment can maintain or grow your “purchasing power” at a reasonable rate over a long period of time.
While you can’t measure this risk with perfect precision, Buffett says you can still make a decent judgment based on a few key factors, such as:
How predictable are the business’s long-term economics? If a company has a durable competitive advantage and operates in a relatively stable industry, it should be easier to predict its financial trajectory. On the other hand, if the business is in a highly cyclical or fast-changing industry, it’s much harder to gauge its long-term prospects.
How competent and trustworthy is management? It’s not enough for a business to have strong financials—it needs leaders who can steer the ship and properly allocate capital. If management is negligent or short-term minded, they can negatively impact a great business’s long-term potential.
Does management prioritize shareholders? Even if management seems competent, they also need to prioritize the interests of shareholders. Do they reinvest cash wisely (metrics like ROIC and ROCE can help assess this) and reward shareholders through dividends or buybacks, or do they waste money on bad acquisitions, empire-building, and other unproductive things?
What price are you paying? Even the best business in the world can be a bad buy at the wrong price. If you pay too much, you’re exposing yourself to more risk, no matter how good the company is. Here’s a super easy way to value a stock.
What role do taxes and inflation play? Even if a business delivers strong returns, inflation is still erosive, and taxes take another bite. So your investments need to produce enough returns to outpace both, or you’re essentially losing ground.
Overall, if you can get a solid read on these five factors, you'll end up making much better (and much less risky) investment decisions. And in the meantime, try not to worry too much about the current market volatility—you’ll be just fine in the long run.
Having said that, I want to hear from you: What's your go-to method for minimizing risk in your portfolio? Write to me here and let me know.
And if you want to find out exactly how much money I’ve made with dividend investing since I started 5 years ago, check out this video here.
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How To Stay Strong When The Market Is TANKING | Ep. 11
In this episode of The Deep End, Ari and I discuss how to stay strong during times like this where the market is heading south.
CAREFULLY CURATED 🔍
📺 The Dark Side of YieldMax ETFs - I've been extremely vocal about my concerns with the YieldMax funds for the past couple of years, and I'm glad to see Brian Bollinger from Simply Safe Dividends—someone I deeply respect—shares similar concerns.
🎧 From Zero To Hero - This episode of Business Breakdowns dives into the fascinating story of Motorola Solutions (MSI). While many remember Motorola for its iconic flip phones of the early 2000s, this under-the-radar dividend growth stock has quietly built on its success through mission-critical communications, a niche customer base, and a more integrated hardware-software model.
📚 Pure Independence - In his latest blog, Morgan Housel shares "a pretty simple formula for a pretty nice life."
SINCE YOU ASKED 💬
“I invested $8,000 into Vanguard's S&P 500 ETF a month ago near its peak, and now, after the recent drop, I'm not sure what to do. Should I sell and take the 5% loss, then reinvest at a potentially lower point? Or should I hold and buy even more if the market dips further?"
- Konstantinos | Email
When it comes to long-term investing, the best approach is usually the simplest one: just keep buying and holding. Timing the market by selling now and trying to buy back in at the lowest possible dip is incredibly difficult and could easily backfire.
Plus, the whole point of investing in an S&P 500 ETF like VOO is that you don’t have to worry about timing things perfectly. It’s designed to be a hands-off, automated way to build wealth over time. All you have to do is keep feeding it!
This is the essence of dollar-cost averaging (DCA): by consistently investing over time—no matter what the market is doing—you automatically smooth out the ups and downs and remove the stress of trying to time the market.
With that said, it's important to remember that the market will naturally have its ebbs and flows, but historically, it has always moved higher over time. Those who kept buying during downturns—whether in 2008, 2020, or any other correction—were eventually rewarded for their patience.
Another thing to keep in mind is that when share prices go down, your investment dollars actually stretch farther—allowing you to buy more shares for the same amount of money, which helps you in the pursuit of building long-term wealth.
While it might be tempting to wait for the market to bottom, the reality is that no one knows exactly when that will happen. So instead of trying to be perfect, just focus on being consistent. That's really all you can control.
At the end of the day, investing is about time in the market, not timing the market.
Even if you happened to buy at what seems like a high price today, years from now, today’s price likely won’t matter much. What will matter is how many shares you’ve picked up along the way and how long you’ve let them grow.
So in short—hang in there, keep buying, and don’t overthink it. You’re already on the right track!
Have a question? Ask me here to see it featured in an upcoming newsletter.
LAST WORD 👋
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