Stock Prices and Risk

Amar Pandit , CFA , CFP

Though the relationship between stock prices and risk is evident, there is a finer point that is always missed.

When stock prices go down, the risk in the portfolio of well diversified stocks also goes down.

When the stock market goes down (as a whole) in value, the risk of the stock market actually goes down.

Why do many then rush to sell when the risk is actually going down?

Reflect on this one for a few minutes.

The reason (besides what happens in our brains – amygdala’s response to stimulus of stock prices going down) many investors panic is because they somehow think that the risk of investing is actually going up.

However, the truth is loud and clear.

Risk goes down when stock prices (a well-diversified portfolio of stocks) go down and Risk goes up when stock prices go up.

If you can understand this viscerally and intuitively (and then act accordingly), you would have learned most (I am exaggerating when I say learned most, but I am sure you get the point) there is in the field of investing.