Investing in individual stocks gives you the potential for amazing rewards. But if the volatility keeps you awake late at night, there's no shame in retreating to the smoother ride you can get from other types of investments.
Even given how strong the recent rally has been, the churning markets have continued to punish certain stocks. Look at a few big movers from earlier this month:
|
Stock |
Day |
Change |
|---|---|---|
|
Principal Financial |
Dec. 3 |
(13.3%) |
|
Aeropostale |
Dec. 3 |
(11.5%) |
|
Kroger |
Dec. 8 |
(11.9%) |
|
Oshkosh |
Dec. 14 |
(11.3%) |
|
FactSet Research Systems |
Dec. 15 |
(12.1%) |
Source: WSJ.
To put those figures in perspective, the S&P 500 has only had annual losses of 10% or more on a dozen occasions in the past 80 years. So to suffer that kind of loss in a single day -- believe me, if that doesn't put you into a panic, you've got nerves of steel.
Understanding risk tolerance
When it comes to investing, everyone's different. Some people are able to take sharp declines in particular stock holdings in stride -- as long as their overall portfolio value drops more modestly, they can handle a bad day from one or two of their individual stocks. A well-structured diversified stock portfolio actually embraces this kind of price behavior, realizing that if a certain stock plummets, other holdings will cushion the blow to your total net worth.
On the other hand, some investors simply can't see their stock portfolios as one cohesive unit. Instead, they want each of their holdings to do well -- and when they don't, it represents a failure in judgment and brings about the pain that losses inflict on our emotions. Left unchecked, these emotions can lead you to make even bigger mistakes than the one that got you to buy the losing stock in the first place.
The solution for skittish investors
As much as your rattled nerves may want to take a break from turbulent markets, you don't have to give up on stocks entirely to get some relief. If the last year or so has shown you that investing in individual companies isn't your cup of tea, you have a perfectly good alternative that will still give you the stock exposure you need for long-term portfolio growth: mutual funds.
Most mutual funds hold dozens of stocks. As a result, when one or two take a big hit, the mutual fund will drop, but not nearly as severely as those individual stocks. For instance, last year, Freddie Mac fell over 25% in a single session on fears that the mortgage lending giant was insolvent. Yet a top institutional holder of Freddie Mac stock, the Legg Mason Value Trust (LMNVX), only lost about 2% of its value that day.
The price you pay
Now it's true that nothing comes without cost, and funds are no exception. You may not bear the full brunt of a Bear Stearns-style implosion, but you also won't get the full benefit of a multibagger stock. The Materials Select SPDR (XLB), for example, counts Monsanto
Still, being comfortable with your investments is important. Investing in stock funds can keep you on the path toward your financial goals, letting you keep broad exposure to the stock market while also helping you avoid the mistakes individual-stock investors make.
If funds make you feel more comfortable during tough markets than individual stocks do, don't hesitate -- make the leap today. Giving up some upside potential on your investments is worth it -- especially if it makes bear markets easier to put up with.
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