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Chart of S&P 500, as of Friday, May 20th 2005
Here I show the S&P 500's performance because this is by far my largest
investment holding, expecially when my retirement accounts (Roth IRA and SIMPLE IRA) are included. The S&P 500 is
also a common "benchmark" of the market as a whole, which also means that this holding is rather diversified by itself.
Risk Management Suggestions:
In general, it is not a good idea to have all of your investment funds tied up in one stock.
Some other types of risk to consider are: Liquidity Risk, Tax Risk, and Market Risk. These are explained briefly
below:
Liquidity Risk: This is something to consider if you are investing in a smaller
company that is not traded as actively as most major corporations. Liquidity is basically a measure of how fast your
investment can be turned into cash if needed. For example, if you have $10,000 worth of General Electric (GE) stock
and you need cash immediately to cover a major event or repair, you could sell that stock right away to obtain cash.
On the other hand, if you like to invest in vintage sports cars or artwork, this may be a way of diversifying, but it would
not be a very liquid investment because it may take weeks or even months to convert these assets into cash through a sale.
Tax Risk: This is always something to consider, especially when we are investing
in taxable (non-retirement) accounts. This can work both ways. Most recently there has been some changes in
our Federal tax laws that give a more preferencial treatment to dividend income than in the past. This means that
the tax implications of receiving dividend income may be more beneficial to you now than they were in the past. When
considering two stocks that pay different dividend rates, this would be a factor to consider.
Market Risk: This is something to consider with all companies. One of the
best tools used to measure this type of risk may be the "beta" of a stock, which indicates how volatile a stock
is, compared to the market in general. A beta above 1 is considered to change more than the market (in the same direction)
in general. For example, if the S&P 500 (beta=1) goes up 10% and your stock has a beta of 1.5, you can expect your stock
to go up by around 15%, on average. While we cannot control the market as a whole, we can control the types of
investments we purchase and we should evaluate the various risks involved before making our purchase.
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