Welcome to Ameritrade Plus University |
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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
Chronic underperformance
Failing to keep up with 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. | ||
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