Investing in the Stock Market & Risk Appetite

Back last August, I was sitting in my office and one of those annoying co-worker types comes in and sits down in one of the chairs facing my desk. She asks what I am doing about the stock market.

First, understand that my real job involves credit risk management and I am constantly involved in monitoring the investment portfolio we hold where I work (about $4 billion). It is, however, primarily in investment grade bonds ... we hold no stocks.

While I was somewhat annoyed as I certainly had other things to do at the time, I was also somewhat buoyed by the fact that she wanted my opinion. So in light of these continued unsettled days in the market, I will convey the following advice ... the same advice I gave her that day ... and the same advice someone gave me a long time ago ...

"If your investment portfolio is keeping you up at night, you don't have the risk appetite to be in that part of the market."

Now, Jim Cramer did say something similar last fall and got really castigated for it, but simply, don't put money in this market (and I would add any market) that you need in the next 3 years. In other words, don't put money in this market you can't afford to lose. Because stocks can go to zero.

My advise is simple ...

1) Plan your financial future with a 3-5 year time horizon. Don't assume big raises (in this economy), don't assume you will always be employed (have at least 3 if not 6 months of salary in cash/savings), and assume there will be some unexpected expenses. Will you purchase a home, a car, will you need to pay tuition? What do you have left? Let's call this money "discretionary".

2) How much time can you invest in managing your money? Do you have time to day-trade? Will you check on your investments daily ... weekly ... monthly ... yearly? Can you afford to pay a percentage of the money you have invested to someone else to manage it?

3) How much risk are you willing to take? Make sure that the money you allocate to investing is money that you can tolerate losing ... and losing all of it.

Your answer will lead you to an investment scenario you can live with.

Money market funds and CDs are the kinds of investments perfect for people with little time to manage their money and little tolerance for risk. Now, you can escalate your level of risk through selecting funds that have a higher risk profile. Use a service like Morningstar to help you. Morningstar is the pre-eminent purveyor of money market funds and have a long-standing history of non-bias and a good rating system and a number of tools on their website (some cost more than others).

Individual stocks require homework. And don't just invest in "what you know". Stock investment requires discipline and diversification. If you don't understand either term, the stock market is no place for you. It is also dubious in this market that the old "buy-and-hold" strategy will make you money. The market right now is for day-trading and professionals, in my opinion.

In the case of my annoying co-worker, I could tell that she was not at all comfortable with the money she had invested in the market. After all, and much to Jim Cramer's original example, she has a son in college. She was gambling with his tuition money! Someone had told her that there was better money to be made in the stock market and she was chasing yield, essentially, but without the homework that should go along with picking an individual stock or bond. My advice to her was to take all of the money she had in the stock market out ... at the most opportune time ... and I told her to put it into something like CDs or insured money market funds.

I think if anything, the debacle in the financial institutions and in the markets have taught us that greed gets us into trouble. And much like the housing crisis, there is this "herd" mentality ... keep up with the Jones' ... a bigger house like the Jones, make money in the markets like the Jones' ... etc.

Make money doing the things you do best and through taking the level of risk you are comfortable taking.

I'd love to hear from you ... make comments, send emails!

Check out my recently published content on AC:

What is Your Risk Appetite? Assessing Your Personal Comfort Level