Money Matters

Understand difference between volatility and risk when investing

The recent day-to-day movement in stock prices has proved investing is not for the meek.

A drop in the Dow industrials of 200 points or more, which has happened 19 times so far in 2015, is a real gut check. Yet, at the same time, there have been 20 sessions where the Dow has gained for more than 200 points.

To be sure, all of this volatility is having a toll on investor confidence. After all, the previous six years have seen stocks move mostly higher with very few significant declines.

For many people, the volatility in stock prices has raised the perceived level of risk involved with owning stocks.

However, the world's greatest investor has repeatedly tried to convince investors there is a significant difference between volatility and risk.

"If the investor fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in 'safe' Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement," said Warren Buffett in his 2014 letter to shareholders of his company, Berkshire Hathaway.

He notes that six years ago the S&P 500 stock index had dropped to 700 and, even with the current correction, is still trading above 1,930.

"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to 'time' market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisers, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy," added Buffett.

Even further, he says, "No adviser, economist, or TV commentator can tell you when chaos will occur. Market forecasters will fill your ears but will never fill your wallet."

Although Buffett has had great success owning the shares of great American companies, he suggests most investors keep their investments very, very simple.

"My money, I should say, is where my mouth is," Buffett said.

He notes a portion of his assets, upon his death, will be distributed in the form of bequests to certain individuals and has instructed his trustees to provide a simple direction to the recipients.

"Put 10 percent of the cash in short-term government bonds and 90 percent in a very low-cost S&P 500 index fund. I believe the trust's long-term results from this policy will be superior to those attained by most investors, whether pension funds, institutions or individuals, who employ high-fee managers," Buffett wrote.

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