By: Dividend Sensei
Volatility is back with a vengeance in 2018. While 2017 saw a 20% market climb with the lowest volatility in over 50 years, 2018 has been a roller coaster. Consider these facts: in 2017 there wasn’t a single day in which the S&P 500 rose or fell 2+%. So far in 2018 we’ve had six such days, three up and three down. Or how about this? In 2017 there eight days in which the market rose or fell 1+%, but in 2018 we’ve had 23 and it’s only been 12 weeks. In fact 2018 is currently on track to be the most volatile year since 2008.
So naturally it’s understandable that many investors, especially those nearing retirement age, are nervous about the market and wondering what they should do to reduce their risk. Well to hopefully help you on your financial journey here are a set of time tested rules that can help you avoid costly mistakes that can torpedo your dreams of a prosperous retirement.
Rule 1: Understand What Risk Really Is
Warren Buffett once famously said there are two main rules to remember when investing: “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1”. A pithy quote from the greatest investor in history, (21% annual returns since 1965), and obviously one that is far more nuanced than it first appears . The key to being a good long-term investor is to first understand what risk really is.
Many investors think it’s market volatility itself, specifically declines in share prices. While that is indeed one measure of risk what Buffett, and most investors, really care about is a permanent loss of capital. In other words losing money. The difference between the Oracle of Omaha and most investors is that Buffett understands that real investment risk is not a temporary, or unrealized, (paper), loss but when your investment thesis goes completely wrong.
For example say you invested in a seemingly good dividend stock with solid fundamentals and strong long-term growth prospects. However years later the entire industry is decimated and the company ended up filing for bankruptcy in which case shareholders got wiped out. A good example would be General Motors which was flying high in the late 1990’s on a wave of cheap gas, a strong economy, and America’s seemingly insatiable demand for highly lucrative SUVs. During the financial crisis it turned out that GM’s credit arm had made numerous terrible loans that caused it to lose $15.5 billion in Q2 of 2017 alone. Only a government bailout, in the form of financing it through bankruptcy to the tune of $50 billion, helped it to eventually recover. And by that I mean that the company survived and its shares once more trade on the stock market. However those are new shares which did pre-bankruptcy investors no good at all.