When people talk about investments, they tend to leave out a missing value that everyone ignores when figuring out their investment strategy. That little tidbit of information would be the massive elephant in the room called: risk. I’ve created a rough draft table giving values between .1 and 1.0 for different investments and the amount of risk I believe they have. Obviously, you may disagree with some of my values, that’s fine! I encourage you to come up with your own values. I think that if you use them in your math when debating an investment it will put a better perspective on what you’re actually risking.
Obviously, the only non-risk investment is putting money under your mattress. We’ll give that a value of 1, so if you have $100 to risk and multiply it times the .1 risk value, you’re “risking” $110. Simple, right? Remember, this is just a theory, it’s not real money values. We’re ‘adding’ in risk to evaluate an investment.
The next most risky thing on my list is a savings account. We’ll give that a value of .2. Really, the only thing that could happen is the bank could go bankrupt or your money could be stolen somehow, not much risk but a tiny bit more than under the mattress. $100 x .2 = $120 of risk cost.
At level 3 we have money market accounts, there’s a bit of a fluctuation there where you could get worse returns on your money, we’ll give it a risk of .3. $100 x .3 = $130 of risk cost.
At level 4 we have CD’s (Certificates of Deposit), Index Funds and ETFs (Exchange Traded Funds). CD’s can be called early, Index Funds and ETFs can fall like rocks, but they are diversified more than a single stock. We group all these together in risk level 4. Note that I omitted Mutual Funds. That is because Mutual Funds suck donkey nuts. $100 x .4 = $140 of risk cost.
Which brings us to level 5 on my list, which I think will be the most controversial. In this level of risk I put the best stocks like Coke, Disney and Microsoft, but I also lumped in Real Estate. Why Real Estate? Because a lot of problems can happen. Bad market, no renters, earthquake, flood, typhoon, rats, termites, water damage, fire, rising interest rates, inability to sell when you need to get out. If you were to hold a house for 80 years, yes you’d make money, but you would have all of these risks throughout the life of the property. Some people will say, “That’s what insurance is for.” True, but that increases the expense of your investment, which also makes this a level 5 risk to me. $100 x .5 = $150 of risk cost.
Level 6 for me includes stocks like Target, Harley Davidson, Apple and Costco. Good businesses now, but will they last forever as they are? Don’t really know. They are also lacking in intellectual property to lower their risks and aren’t diversified businesses. $100 x .6 = $160 of risk cost.
Level 7 are stocks that are tech related that can change on a dime. AMD, Intel, Dell, ATI. All of these stocks are extremely dependent on the current technology trends. Yes, computers will always be around, but will Intel put AMD out of business? Vice-versa? Will a new chipset come out? Will Dell continue to rule the PC sales? Will Apple affect Dell? A lot of what-ifs. $100 x .7 = $170 of risk cost.
At level 8 I put all of the stocks I wouldn’t touch with your 10 foot pole with the bulk of my money. These are the highest risk stocks in my book. Airlines, Drug companies (for the most part), Satellite Radio, Hotels, Car makers. All of these companies live in such volatile markets where the fad of the day can turn them on a dime, where a single mistake can create lawsuits that destroy the company or recalls that could bankrupt them, or companies in a technology that haven’t been proven to be popular yet. I must note that I did make my greatest gain ever in this level when I bet almost everything on Sirius on the day Howard Stern made his announcement. Unbelievably great news will send these stocks up quickly, but then get out! Only risk 10% of your money at most in this level. $100 x .8 = $180 of risk cost.
Level 9 is sports betting. You have a good idea of who will win, but it just comes down to a flip of the coin. At least you can bet based upon who’s playing and previous track records. (If you bet against the Kings to win the Stanley Cup this drops to a .1 risk) $100 x .9 = $190 of risk cost.
Level 10 is just throwing your cash away at Vegas. It’s even worse than a flip of a coin. For every $100 you are betting in Vegas (or any casino for that matter) you’re pretty much risking $200 when you factor in the risk.
Now, obviously, you are always risking $100 in the above scenarios, but I think it’s most important to manage your risk, especially across your entire portfolio, and this little study in mind manipulation factors in the ‘unknown’ that we avoid that is risk. How many level 8 risk stocks do you have verses level 4 risk stocks? Would you be willing to place .8% more cash into those investments? Are they worth the amount you’re risking in them? Could you move that cash into a .7 or .6 risk investment and feel better about the risk level and investment overall? Is a majority of your money in level 7 or 8 investments? You might want to move a majority of that money into something lower risk.
Obviously, we all want to hit the home run and to do that you usually have to play in the riskier investments, but try not to ignore the risk as part of your equation. Factor the risk in and use it to your advantage to diversify the risk of your investments.
Invest in peace…