Wednesday, December 25, 2013

Bullshit financial theories part 2: Volatility is risk

For anyone who has taken an investments & portfolio management course in university, you would remember being taught that risk is fluctuations in stock prices. Well, I’m here to tell you that standard deviation, Sharpe ratio, beta and other measures that treat stock price volatility as risk is fucking bullshit. Don’t get me wrong, I think that my banking & finance degree was worth the money. I found subjects like treasury management, lending decisions and money & capital markets extremely useful.

I agree that stock prices are volatile. Stock prices fluctuate all the time as there are a lot of jackasses that invest based on chart patterns, Fed announcements or other such nonsense. You have people (who think they’re geniuses) who believe idiotic stuff like “now is not a good time to buy stocks because the index is facing resistance at 3,000 so it should drop back to 2,980.” Yes, there also are times when sharp price swings are rational (like finding out that a company’s recent initiative is a success or finding out that a company has been cooking its books).

My point is that there will always be volatility. But if you invest in a good quality company at a reasonable price for the long-term, then you shouldn’t give a damn about what the stock price does in the short-term (except if it gives you an opportunity to buy more at a lower price). I generally invest in a company only if I’ll still be comfortable if the stock market suddenly shuts down and I have no choice but to hold the stock for many years. That’s because I’m buying an interest in a fucking business, as long as the company is financially stable, its business fundamentals are alright and it keeps paying me dividends, then there’s nothing for me to worry about. The reason Charles Koch or Robert Kuok establish a business is to get income from it for the long-term, not to sell it for a profit in a few months. The same principle applies to stocks. Sure, if Mr Market comes along and offers me a good price for my stocks, then I might take it. But that’s a bonus and I don’t think too much about it.

Some people might say stuff like “what if the stock price drops and my ass get a margin call’ or “I can’t afford to pay my mortgage next month because Coca-Cola dropped 5%.” Well, maybe you won’t get into debt troubles if you only used a conservative amount of leverage and used a bank deposit as collateral instead of shares.  Maybe you shouldn’t be using debt at all if you don’t know how to manage your cash flow, there’s absolutely no shame in that. And for those short-term investors out there, you’re just gambling and deserve to lose money.

What if you lose money even if you hold a stock for the long-term? Well, sometimes you do lose money because you made mistakes in your analysis or competitive forces change unfavourably for the company you invested in. That’s the risk you take with investing. That’s why you need to diversify your portfolio so that mistakes don’t cost you so much. If you adequately diversified your portfolio and still experienced losses over the long-term, then it could be a sign that you’re not cut out to be an investor and should just invest in mutual funds. There’s no shame in that.


There are many real risks that you need to worry about. Liquidity risk, concentration risk, financial risk, credit risk and country risk are some of the real risks you need to take into account. But if you structure your portfolio right, stock price volatility is not something you need to worry about. Thank you for reading. Stay rational and take care!

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