Welcome to Ameritrade Plus University
investing 101Identifying your real risks
Aiming for a realistic return
Identifying your real risks
Putting together the right portfolio
The psychology of investing
Investing for growth
Seven questions to ask before buying a growth stock
How to spot value
Selecting stocks for income
How to buy bonds
Preferred shares: uncommon values
Convertibles: the best of both worlds
Closed-end funds: their time will come again
The right way to use stock options
Mergers and acquisitions
Frequently asked questions I
Frequently asked questions II
Stock screener

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The Sivy 100
About Investing 101

An interactive course for managing your finances


Volatility is only one part of the equation -- and the least important one. Here's what to consider to ensure you reach your long-term goals.

Gauging risk turns out to be a lot tougher than most investors think. The problem is that there are really several different types of risk, and most market analysis focuses on the least important -- volatility. People look at volatility first because day-to-day share-price swings, gauged by a statistic known as beta, are easy to measure.

But temporary price fluctuations don't mean much. What really matters is the average growth rate a stock achieves over long stretches of time. Consider the case of Applied Materials, the world's leading maker of semiconductor manufacturing equipment. The company's business is terrific but erratic, because it's closely tied to the ups and downs of the cyclical semiconductor industry. As a result, Applied Materials' share price has dropped by 50 percent within a 12-month period three times since 1995. But over the same period, the company has averaged a 29 percent earnings growth rate.

In a well-balanced portfolio, you can afford to own a few stocks that move like yo-yos (or have high betas). The key is that they also offer above-average growth rates. Smart diversification will reduce the impact of sharp price swings by one or two stocks.

The risks that truly matter are those that could prevent you from reaching your ultimate financial goals. Three of these dangers can be especially damaging:

Irrecoverable losses
Short-term price dips don't have any significant effect on your portfolio. Multibillion-dollar corporations such as Procter & Gamble usually recover from even serious setbacks. But that's not necessarily true for small growth companies. Not many of the dot-coms that have been crashing -- like drkoop.com -- are likely to bounce back. And it may be impossible to make up for the impact such big losses have on your long-term return, even over a 20-year period.

Chronic underperformance
At the opposite end of the scale, being too cautious can reduce your investment returns so much that it's impossible to reach your long-term goals, even if you never have an irrecoverable loss. For example, if you keep all your 401(k) money in short-term income investments, your balance will never decline. But you'll probably end up with only one-quarter of what you could have earned with blue-chip stocks.

Failing to keep up with inflation
It doesn't matter what nominal return you get if consumer prices soar even faster and erode your purchasing power. That's why electric utilities often turn out to be better long-term income investments than bonds. Even though the utilities may pay less today, their dividends grow over time, unlike the interest payments on bonds. And growing dividends will help keep you ahead of inflation.

If you avoid these significant risks instead of worrying about daily price swings, you'll have a much better chance of beating the market in the long run and ultimately hitting your financial targets.

Putting together the right portfolio >>


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