Stocks, Levels of Risk

Risk is undoubtedly the first thing that comes up whenever I talk to my friends about Investing in Stocks. The response is normally, "I'm Super Low Risk Right Now" or "I can't afford to take an L right now". Understandbly so. Because of Covid, in the months of April & May we've seen over 30 million people file for Unemployment, Companies furloughing or completely laying off employees. Even so, if you've found yourself considering investing in stocks, but aren't sure how to navigate risk, Let's discuss.

Risk Levels: Investments are truly about managing risk, AND, getting rewarded for that risk. Whether it be starting a business, going to school, getting a graduate degree, you hope that by investing either time, money, or resource, there is a reward associated with your investment. Either for yourself or for others. This is also true when stocks

Let's itemize 3 levels or risk, HIGH, MODERATE, LOW. We will dive into these in a bit. To start, Let's discuss a 4th level of list, SUPER LOW RISK. If you're SUPER LOW RISK, there are other investment alternatives in the marketplace that aren't stocks. For example:

• Government Issued Treasury Bonds, Bills, and Notes which offer returns of .125% to 2% (1 cent to 2 cents profit on every dollar invested). Treasury Bills offer the lowest interest rate approximately .125% for a very short period (ranging from days to weeks), Treasure Notes offer around 1% return for a 10 year period. Treasury Bonds last the longest (30 Years), and offering an interest rate around 2%. Returns are lower, because of the associated risk. After all, Treasury Bills, Bonds, and Notes are backed by the FULL WEIGHT of the U.S government.
• High Yield Saving Accounts offer up to 1% or 1.5%, compared to my regular Bank of America Savings Account that offers .03%, a complete joke.
• There are also Certificate of Deposits (CDs), that offer between .6% to 3% return based on duration of the loan (months to years) - The longer the term of the CD, the higher in interest. My sister used to invest in these til she started Investing in stocks. She hasn't looked back since.

Market Trends

Now let's compare some of the SUPER LOW RISK returns discussed above compared to stocks returns which can offer anywhere from 5% to 30% returns Year-Over-Year. For some investors who've chosen wisely, you've seen your portforlio grow by double digits Year-Over-Year. We've seen companies like NVIDIA go from $21 a share to over $350 a share in the last 5 years, we have seen a similar trend with FAANG stocks. Amazon being the highest gainer in that period going from $400 to just under $2500 in the same period.

We've seen similar growth trends with Market Indexes that capture more complete picture of the Whole Market, the S&P (which covers the 500 biggest companies in the U.S) has grown from $2000 to a little over $3000 in the last 5 years, The Nasqad composite has almost doubled in the same 5-year period from $5000 to just under $10000, currently hovering at $9800. The Dow Jones Industry Average just like the other two major indexes has seen impressive growth from $17000 to $28000 in that same 5 year Period. We can defintely see the trend, it's going up up up.

So I'm not saying you should consider stocks, but you should DEFINITELY consider stocks.

Moat

Before we discuss the levels of risk, i'd like to introduce a term that I think will be useful as we go on: Economic Moat. A moat is basically something that gives you some natural advantage against your competition. An Economic moat would be something that gives one company an advantage over others in some area or compeition. For example VISA, the payments processing company. VISA such a big percentage of all electronic payments in the world that it kind of insulates the company from competition. Most merchants that accept Credit or Debit Cards accept VISA, compared to American Express or Mastercard which are not as ubiquitous. Further more, all those Credit Cards from Retailers like Best Buy, Macys, Target, etc, payments processed by VISA. As a payments processor, VISA has a WIDE economic moat. The highest rating possible.

Risk Scale

Let's circle back to the 3 levels of risk mentioned previously. I'd like to think about risk not as litmus test but as a range, even within the 3 levels of risk, there's a gradient.

High Risk Investment Profile

Though high risk, these companies tend to offer higher returns. Below, i've identified some characteristics of High Risk Stocks.
Newly listed companies who still have to demonstrate a track record of sustainable growth over time. During good and challenging times(Shopify, Twilio, Crowdstrike, Uber, Lyft, Datadog, Peloton, MongoDB, Tesla).
New Companies that have huge potential (performance metrics like high revenue growth, low expenses) but are not yet profitable (Livongo, Peloton)
Legacy companies experiencing disruption but are adjusting there business model to adopt to the market. (I can think of Target, Walmart restructuring their businesses to handle online orders/delivery. Gotta avoud being SEARS/JC PENNY)
Trading Options. From personal experience, I can say Trading Options offers unresistable returns. You can double, tripple, even quadruple your options premium (the amount you pay for an option) in a matter of days, or weeks. They are high risk by default because you could lose you entire investment. However, the rewards are too great not to consider.

Moderate Risk Investment Profile

Well established companies with strong brand recognition worldwide with a WIDE economic moat and substantial growth potential. These companies have an unavoidable footprint in our lives. Companies like Microsoft, VISA, Apple, Google, Amazon, Disney, Qualcomm
During times of Economic Uncertainty, Investors tend to prefer these companies because these companies will still retain substanstial revenues, even pay dividends. VISA for example paid Dividends from Q1 2020 quarter despite a global pandemic that drove many companies were into survival mode (Cutting Costs, Laying off employees, cutting back on expansion projects, etc)
Trading Options. I'm on the fence about adding trading options in the Moderate Risk Category. I'm adding it in the catergory for the simple fact options can be used to moderate risk. Your loses are only capped to the Options Premium, the upside is essentially unlimited

Low Risk Investment Profile

These tend to well established companies with little to no competition and are a necessity to sustain life. Low risks companies tend to offer little reward in terms of growing stock price. These stocks tend to remain flat unless there's major regulations changes or significant disruption in their industry. Some examples include

• Utilities Companies, because you have to have electricity.
• Defense companies, it takes some serious Defense Spending to be a World Super Power. As such, Defense Companies tend to see stable revenues from Government Contracts.
• Pharmaceuticals & Drug Makers. You need medicine. Companies like Pfizer who have entrenched drugs like (Epipen, Viagra, Xanax) tend to see less fructuaction in their revenue in good or challenging times.

Final Thoughts

Regardless of risk level, new investors should take extra caution when considering stocks with a high entry price like (Amazon at $2500, Shopify at $730, Chipotle at over $1000). If Disney ($DIS) trading around $120 loses 10% of it's value, An is Investor is only losing $12 per share. If Tesla ($TSLA) trading at just under $900 per share loses 10% of it's stock value, It means an investor is losing $90 per share. Weigh the risk/reward potential for each particular stock investment.

Last but not least, Uncertainty.

Uncertainty from a market sense means not knowing how the future will affect a company, an industry, the economy, the world. Uncertainty can affect the entire market, or it can affect a single company. The impact of Covid-19 for example, highlights true uncertainty in the marketplace. Even though some companies have performed better than others during this on-going pandemic, there still continues to be a lot of uncertainty. When will people go back to work, which companies can work from home, are team members productive at home, which companies can still produce good and services, how much consumer demand will be there, will consumer demand be enough to keep companies in business, how much supply of goods is there, how does an economic recovery look like? So many unknowns, variables that make it that much harder to run a business. As a Investor, you have to ask yourself what level of Uncertainty are you comfortable with.

Being able to qauntify, qualify risk & uncertainty will give you an edge. There is no litmus test when it comes to risk, take stock of market conditions, learn and adopt. In Part 2, we will look at "Morals, Ethics & Beliefs" & "Investment Timeline" as factors in Building or Determing Your Investment Profile.

All ticker prices noted in this post were recorded between 6/7/2020 to 6/8/2020

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