Day trading was trendy decades ago and popular again today, helped along by apps like Robinhood. Many people feel it’s an easy way to make money and earn a return on your investments; many others who are out of work due to the pandemic feel it’s a viable way to earn an income while unemployed
But despite what news articles (or your friends and co-workers) may say about this investing style, the fact is it’s extremely unsustainable. Investing in single stock positions introduces you to a much higher level of risk than you may truly be comfortable with.
The returns might look flashy, and if you’re not currently buying stocks, you may feel like you’re missing out. What you really might be missing, however, is an understanding of the kind of risk that comes with the promise of big rewards.
You Can’t Talk About Returns without Considering Risks
It’s easy to dismiss conversations about severe risk as overanxious hand-wringing from super-conservative investors when we continually see the same companies becoming exponentially more valuable; think Amazon, Netflix, Facebook and Apple, to name but a few.
It seems impossible that these companies — and their stock prices — could ever fall through the floor. It feels inevitable that they’ll only continue to increase in value, and therefore, provide investors with more profit.
This is just one, tiny example that should serve as a red flag — a crack in the idea that these companies will obviously and continuously increase in value.
Even if you can come up with a great bull market case for Tesla (or any other hot company right now), the fact remains that you can’t talk about massive returns without also talking about outsized risks.
Understanding the Risk You Take with Your Investments
Let’s be clear here: Risk is not an inherently bad thing! We need risk in order to get a return. One of the principles of investing is the risk-return trade-off, where a greater degree of risk is supposed to be compensated by a higher expected return.
If we take no risks with our investments — say, keeping all your money in cash — there is no opportunity for return. You can see that right now by looking at the interest rates offered on even high-yield savings accounts or longer-term CDs. It’s close to zero.
Factor inflation into that equation and you’re actually losing money if you keep it in cash.
Smart investors know that risk is important, but not all risk is created equal. To invest strategically, you must understand, identify and take calculated risks. This means taking the least amount of risk that you need to gain the maximum amount of return you require to meet your goals. And there are very, very big differences in the risk profiles of someone who:
