I can make you instantly richer, and safely, by explaining a finance concept with a story about a dog.
There’s a hole in your pocket you probably don’t know about. You may feel instinctively that something is wrong, but unless you look in the right place, you won’t find the problem. The money you’re losing doesn’t appear in the minus column on your account statements, but you’re losing it nevertheless.
Frustrated? Don’t be. I’m going to tell you where to look and how to stop the drainage.
Volatility is every investor’s worst enemy. Over time, it poisons your returns. Unlike a 2008-style market drop, though, volatility poisons them slowly. There’s no obvious ailment to discuss with friends or hear about on CNBC. You only see it when you compare how much you lost to how much you could have earned—and looking back at your own mistakes is not a pleasant thing to do.
So instead let’s imagine two fictional companies: X-Cite, Inc., an amusement-park operator with a volatile stock price that adventurous investors love; and Glacial Corp., a dull, defensive sloth of a corporation whose stock returns are consistent but often lower than those of its more glamorous counterpart.
Average return on both companies’ stocks was 5% for the past five years, but Glacial’s was less volatile. Safety is comfortable, but doesn’t higher volatility mean higher potential returns? Sometimes, but not always. When you accept high volatility, your returns might be higher at times, but they also might be lower. In other words, higher volatility generally means greater risk.
Nothing new so far, but the oft-overlooked point is that boring stocks make you richer over time.
The chart below shows each stock’s annual return over a five-year period.
At first glance, Glacial Corp. appears to be the loser. It underperformed X-Cite in four out of five years. Both stocks returned 5% on average during these years, and X-Cite was almost always voted the prettiest girl in town. But for Year 3, it would be easy to persuade investors to buy X-Cite stock. Few would give Glacial a second glance.
