I'm not a gambler. I have defied my Baptist upbringing on a few occasions to visit "the boats." But my visits were more out of curiosity than out of a belief in finding great riches.
I worked up my courage to sit down at the blackjack table one time and made the dealer quite nervous. You see, I was so busy counting my chips, I slowed down the game. My goal was to get out of there with the same amount of money I had going in. I had no intention of breaking the bank and no intention of digging deeper in my pockets to keep this insanity going. And when I was $50 ahead, I proudly picked up my chips and headed for the cashier.
I decided I didn't have the stomach for the business.
No, I'm no gambler. But I am an investor, and so is everyone who has bought stocks, bonds, CDs, annuities, etc., etc. Some people think of investing as gambling. You put your money in the market, pull the handle and wait to see if you hit the jackpot.
And that may be the way things work in the short-term. But in the long-term, investing offers greater odds than a one-armed bandit or even a blackjack table.
Investing still has risk. The trick is to find that level of risk that you can live with. For some, anything without the word "guaranteed" is too risky for them. Others prefer risky "go for broke" investments.
In my business, we define risk as volatility. That is, an investment is considered risky if its price fluctuates widely.
We spend hours calculating and measuring risk using all sorts of statistics. We quote standard deviations, ranges, betas, and on and on to describe how risky an investment is. And we miss the point.
Because for the average Joe or Jane out there the question is: "Will I lose?" While the market is steadily dealing its cards, we are constantly counting our chips and asking that question.
Will we lose principal? Will we lose opportunity? Will we lose purchasing power?
Loss of principal has less to do with volatility and more to do with time frame. If I have only one year to invest my money, investing in stocks would be risky. While the stock market offers the highest (historically speaking) returns, it fluctuates widely. If I invested $1,000 in the Dow Jones Index last month, I would be crying the blues right now if I needed that money within the year. I am taking the risk of having to cash out in a market downturn and losing my principal.
But if I have 5, 10, 15 or more years to invest, stocks would be less risky. Those wide fluctuations in the meantime would be of little concern to me. With a long enough time frame, I could probably outlast a market downturn and not suffer that loss of principal.
And that brings us to the second point - loss of opportunity.
If I invest my retirement money in those "safe," conservative funds, I risk my standard of living upon retirement. I'm choosing short-term safety for long-term money. And I'm missing out on the opportunity to build my retirement nest egg with those higher stock market returns. So, when the stock market starts going crazy, as it has lately, don't focus on those wide fluctuations. Remember your time frame.
And what about the loss of opportunity when you have a bad investment in your portfolio? So many people get stuck on how much they'll lose if they give up on that stock or fund or annuity, and they insist on keeping their money in a poor investment. They forget that while they sit there with a dog, the racehorses are flying around the track. They miss out on the opportunity for better investments.
Loss of principal is easy to measure. If I put in $1,000 and get back $1,000, I haven't lost. But what if that $1,000 I get back now only purchases $900 worth of stuff? That's loss of purchasing power. If you bury that $1,000 in the backyard and dig it up 20 years later, you'll still have $1,000. While your "investment" won't be worthless, your money will be worth less.
Purchasing power risk is just as real as risk of principal. Both erode your original investment, but many people continue to choose those investments with the word "guaranteed" because of their greater concern for loss of principal. They leave money in a low-earning savings account because it's safe. But they forget that inflation has averaged about 3% for most of this century.
That means if you don't earn at least 3%, you're probably losing. It also means that your real return is only that amount over the inflation level. If inflation is at 3% and you are invested in a 5% CD, you are really only earning 2% on your money. And if this is long-term money, we're back to that loss of opportunity. No, I'm no gambler. The market is dipping and diving all over the place, but, for me, it's a safe bet for the long haul. So, quit counting your chips. This isn't blackjack!
--Nancy Lottridge Anderson, Ph.D., CFA, Mississippi Business Journal, April 7, 1997