Stock Based Funds
The most popular type of mutual funds, by far, are the ones that are based upon certain baskets of stocks, either ones picked by the fund manager or all the stocks in an index which the fund tracks.
Index funds have been more and more popular over the years, as the majority of funds that are actively managed deliver both inferior results to the market as well as higher management fees than the passively managed index funds.
Stocks have the highest potential for growth among any investment, although among stocks, there are some that have more potential for others, growth stocks, and some that are relatively quite conservative.
With this greater potential also comes more risk, because what can move up rather quickly can also move down just as fast, or faster in some cases. The tendency for an investment to move over a given period of time is called volatility, and some stocks can be plenty volatile indeed.
The standard approach to investing and the one used by the great majority of investors these days focuses on long-term speculation, looking to take advantage of the established trend of stocks to rise over the long run and rise pretty nicely.
We really don’t have much of a statistical sample of long-term trends because the market simply hasn’t been around all that long from a long-term perspective. The fact that does tend to move ahead over 30 or 40-year timeframes isn’t really all that proven of a concept statistically speaking, since we really haven’t had a lot of 30 or 40-year periods since stock markets started tracking these things.
We do have a century of statistics, but this isn’t long enough to say with a high degree of confidence that this will continue indefinitely. The world has seen a whole lot of economic growth during this time, but this has started to slow down due to our approaching our capacity more.
This may seem like the best game in town in spite of the fact that we assume that these trends are more proven than they actually are, and it’s not really that unreasonable to play these trends. The problem is that, over time, these longer-term horizons become shorter ones, and end up evolving to where the current time frame, from now until we need the money, becomes less and less reliable.
Managing Stock Market Risk
It’s a far different story for instance to take random entries into the stock market and only hold them for, say, 5 years, where we may end up ahead by a very good amount or behind by a lot.
The real risk with investing isn’t so much where it has been on its journey to our cashing out, it’s where it is when we do cash out, and we should be looking to at least tone down these risks. Contrary to popular thought, investing in stocks without any risk controls is a pretty risky proposition, exceeded only by leveraged products where risk can be amplified far more greatly, even though nominal risk may be much less.
Leveraging long-term positions in stocks is a terrible idea though for many reasons, where even a little leverage such as 2:1 does not perform anywhere near as well over time as unleveraged positions. We end up increasing the risk of the stock positions even further, without seeing a corresponding rise in returns, due to the cost of borrowing.
Traders who use leverage, at least the successful ones, pay very close attention to risk management and can reduce it to a level considerably lower than owning the stocks and staying long with them produce. When we just hold things with no controls, this does not even define our risk and leaves us exposed to whatever degree of pain that fate may visit upon us due to our positions not being defended in any way from this.
With this in mind, it does pay to pay at least some attention to the risk that we are exposing ourselves given that there is so much on the line with our retirement money. People will often tell you that no investment is so sacred as their 401(k)s, but their words do not translate into action, mostly because they don’t have much of an idea what to do.
Market risk is instead simply accepted by people, and they cast their stones upon the water and hope that the gods will be kind to them, but it is all up to the gods given that their plan is no further involvement in the investments until redeemed.
As our investment window shrinks, this is where we need to be most aware of this, as there may not be time for our portfolios to recover from some of the big hits that bear markets can lay on us, and this means selling while things are down, which is not a good proposition at all.
Other Investment Options Besides Stocks
While stocks do form the bread and butter of 401(k) plans, and in many situations, they should be, this really does need to depend upon the situation much more than it currently does generally.
It’s hard to go too far wrong with an index fund and they are good choices for people to hold their stock positions in to the degree that they wish to be exposed to the stock market. Indexes tend to be less volatile than many stocks although in a market downturn, both stocks and the indexes that comprise them do head in the same direction.
There are two main considerations that should influence our wanting to be more or less exposed to the stock market, which are market performance and time horizon. The better the market is performing, and the more time we have, the more we should be invested in stocks with our 401(k)s, and the poorer stocks are performing and the less time we have to invest, the more we should prefer other investments such as bonds or savings type investments.
We do look to simplify things by excluding market performance and downplaying time horizon, and this might suit or seem to suit those who do not choose to become actively involved in deciding on where the money in their 401(k) should be, but when this oversimplification leads to our not getting the returns we could or placing our money too much at risk, we should at least rethink this approach and consider what the alternatives may be.
Perhaps oddly, we really don’t do much about these risks and usually do not do anything, and when things turn sour, we instead blame others, the funds, the market, bad luck, or whatever, when we are really the only ones that can help ourselves avoid the unpleasantries or even disasters that investors fear and sometimes experience first-hand.
Bonds are not as volatile as stocks, but do go down in value, especially in times of rising interest rates. If you buy bonds and the interest rates go up, the value of the bonds will go down, and will do so surely as the sun rises.
This makes managing bond positions fairly simple, as we just need to look at interest rate trends and forecasts, and these forecasts do tend to be pretty good. Bonds are driven by fundamentals mostly, where stocks never really are, directly anyway, and are instead driven mostly by influxes and outfluxes of funds in and out of stocks in general.
Stocks do tend to move in a fairly orderly fashion, and while it is impossible to predict anything with certainty, we can look at the way things are moving and make some pretty good predictions.
It’s not that we really need to predict anything that far out there when we’re looking to time the stock market, as we can just determine what direction we’re moving in overall and stay in as long as this continues. When we see a reversal of this, this is our call to action.
The same can be said of bonds, and bonds do follow trends as well. There is always what is called noise in markets, movements that are not significant, but the significant ones do speak loud enough that makes them easy to hear.
It is not always the case then that we want to use bonds as our default safe haven when stocks are struggling and we’re looking to manage our portfolios accordingly, as we should be instead looking toward what may perform best at a given time. If stocks and bonds are both struggling, then savings vehicles then become the safer and more sensible option, because a small positive return beats a negative one every time.
People are afraid of doing the wrong thing here, and this isn’t just something that you can just start out with and know what you are doing, and this does take at least a modest amount of study and understanding.
The main goal here when we are doing this, if we dare to that is, is to manage our investment risk, to protect our hard-earned assets that we’re planning on using to ensure our retirement years are fairly comfortable ones.
The more people manage their own investments, and the more they get away from the simple buy and hold approach, the more volatile markets will be, because more people will be trading in the direction of large trends, extending their magnitude and duration. This should not be something that scares us though, as with more volatility comes greater opportunity, as long as we are on duty and both keeping an eye on things along with the resolve to take appropriate action when indicated.
What we have our money in with our 401(k)s can indeed be a pretty big deal, but only if we are resourceful enough to seek out where the money should be at a given point in our journey.