Wednesday, August 26, 2015

Stock Prices ... Know the Difference Between Risk and Volatility ... And Act Accordingly

Stock prices in U.S. markets started off higher and ended lower yesterday.

Although U.S. stocks are set to open higher again today, we could be in for another 'up-then-down, down-then-up' episode of volatility today. Nobody knows.

In any event, markets fell in China today and are falling in Europe. In the U.S. prices are set to rise. See Global Stocks Struggle to Shrug Off China Fears which is subtitled 'European shares fall after another volatile session in China.'

A friend said recently that he had 'lost' $50,000 in the stock market. But did he really?

In other words, did he sell and realize the actual loss compared to what he paid for the shares, or does he still own the shares and have a currently unrealized 'paper' loss of $50,000? Or does the $50,000 even represent the difference between what he paid initially for the shares and what he received when he sold those same shares?

The prices that matter most are what we pay to buy shares and then what we receive when we sell them --- not the volatile pricing that inevitably occurs between those buy and sell dates.

The difference between what we pay and what we receive upon selling those shares is the actual REALIZED gain or loss on the principal amount of the shares owned. But that's not all.

We also need to take into account the cash dividends received during the time we owned the shares.

And that's why I'm staying invested in stocks for the long haul. Share prices over time will rise, and growing cash dividends will pay me along the way.

In fact, currently ten year U.S. government bonds yield ~2% and the dividend yield on blue chip stocks is ~3%. That's an increase of 50% in favor of stocks.

At the end of the ten years, the government will return my initial investment in bonds. At that time I'll need to find another investment for the money returned, assuming I don't need the entire amount in cash. And if interest rates increase in the interim, which they will, I'll receive less than $10,000 if the sale of the bonds occurs before the ten year bond maturity due date.

But with dividend paying stocks, cash dividends during those ten years will grow by perhaps 100%, thereby yielding ~6% on the initial investment. But what I like even more is the likelihood that the shares will then be worth more than double what I paid for them.

So here's the deal, fellow individual investors. If you need the money in the near term and the market sells appreciably higher today, then sell the shares and realize the gain or loss in relation to what you paid for the shares.

But if you have an unrealized paper loss compared to last month's price or even what you paid to buy those shares, then please carefully consider the genuine risk involved with emotionally driven selling in a volatile trading market.

Market prices are extremely volatile right now, but over the long term the bigger and very real risk is in not owning a diversified basket of blue chip (1) dividend paying, (2) dividend growing and (3) REALIZABLE price adjusted inflation beating stocks.

That's my take.

Thanks. Bob.

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