Every single day, investors can find stories all over financial news sites of stocks that are up 50 percent that day. These stocks deliver huge gains for investors after a big earnings beat, a new partnership deal or sometimes for no obvious reason at all.
It’s perfectly reasonable to look at a daily stock portfolio gain of 0.2 percent and be envious of traders who pocketed 70 or 80 percent gains that day. However, as tempting as it is to chase volatile stocks for potentially huge gains, it’s rarely the smart decision.
It may seem like the wealthiest investors are the best at picking winners and losers in the market. But as it turns out, wealthy investors are often more focused on risk management than huge gains.
A 2016 study by Spectrum Group found that the wealthier an investor gets, the more likely he or she is to invest in exchange-traded funds rather than individual stocks. One of the primary advantages to ETF investing is diversification, a phenomenon which limits the potential damage that a small number of stocks can inflict on overall performance. Of course, the lower risk of ETFs typically comes at the cost of sacrificing those 50 percent daily gains.
The more diversified an equity ETF is, the less likely it will be to outperform the stock market as a whole. Index ETFs, such as the SPDR S&P 500 ETF (SPY) and the SPDR Dow Jones Industrial Average ETF (DIA), are designed specifically to mirror the returns of the overall market. These ETFs rarely move more than 2 percent in a single day.
While daily gains and losses of less than 2 percent may seem like a boring approach to investing, diversification and risk management are essential parts of investing for the long haul.
“Those that have long-term success think about consistent, realistic returns that minimize risk,” says JJ Kinahan, managing director of client advocacy and market structure for TD Ameritrade. “They do not think about 100 percent returns and get rich quick.”
Owen Murray, director of investments for Horizon Advisors, says that young investors typically have the most to gain from a conservative approach.
“It is difficult to contemplate a future that is several decades ahead when they are just beginning their career,” Murray says. However, starting early and being consistent is the key to maximizing investment gains over time.
“Picking the right stock or mutual fund isn’t nearly as important as setting up and sticking to an investment plan.” Murray says. “The irony is that young investors, who have very long time horizons, tend to be far less patient than older investors who have much shorter time horizons.”
Investing in index ETFs might not deliver the kind of exciting gains that will provide a daily adrenaline rush. But long-term investors can take comfort in the fact that the stock market has been remarkably consistent over time.
Recessions come and go, but the rolling 30-year annual return of the Standard & Poor’s 500 index has stayed between about 8 percent and 15 percent since 1926. In other words, even if you started investing right before the Great Depression began, you would still have generated an average annual return of at least 8 percent over the next 30 years.
That consistent, long-term return is what builds wealth for investors.
According to Nicholas Colas, chief market strategist for Convergex Group, chasing volatile stocks on a daily basis can be no better for your finances than gambling. Colas says only a handful of the most experienced traders with the best resources are able to consistently make money in the short term.
“Over the long term, however, an individual with a well-diversified portfolio and lots of patience can do as well (or better) than many professionals,” Colas says. “If you want excitement, take $100 and go to the casino. If you want to see it grow over time, invest it wisely and then leave it alone.”
Colas isn’t the only one who uses…
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