• Create BookmarkCreate Bookmark
  • Create Note or TagCreate Note or Tag
  • PrintPrint
Share this Page URL
Help

Chapter 6. Foolish Risks > Active Risk Management

Active Risk Management

Another common belief is that firm-specific risk can be managed by trading skill and knowledge. Specifically, investors are encouraged to invest in too few stocks because they believe that they will be able to avoid big losses by selling a stock when it looks weak. That is, investors believe they can manage the risks of an underdiversified portfolio by actively monitoring and trading the stock. People imagine that they can see a bear market coming or bad news for their firm and will have the presence of mind to sell quickly before losses get too great. They see patterns in the stock price over time and determine buy and sell points. However, stock price patterns are largely imagined (see Chapter 3, “Patterns and Predictions”) and trading on them opens the door for an investment blunder sometime in the future. Besides, do you really know whether a recent decline in the stock market is a correction (thus, a buying opportunity) or the start of a bear market (which is a good time to sell)?

Yet, investors seem to believe that active monitoring of a few stocks has lower risk than holding many stocks. Consider the attitudes of 45 investors in Wisconsin who attended an investing conference sponsored by the National Association of Investment Clubs. For equity investments, these investors invested only in stocks, not in stock mutual funds. In addition, they had an average of 18 years investment experience.[10] These investors were shown a statement and asked if they agreed or disagreed with it. Nearly 90% agreed with the statement, “I would rather have in my stock portfolio just a few companies that I know well than many companies that I know little about.” In short, they believed that concentration was better than diversification.


PREVIEW

                                                                          

Not a subscriber?

Start A Free Trial


  
  • Creative Edge
  • Create BookmarkCreate Bookmark
  • Create Note or TagCreate Note or Tag
  • PrintPrint