Last night I had a really hard time falling asleep – I was
mulling something over and trying to self-analyze my emotions, and it’s also really
hard to fall asleep after watching the Olympics. After refreshing facebook about 8 times and realizing there
was nothing on the internets that I hadn’t already read, I decided to
distract/calm myself by calculating how much money I had saved, and how much of
my income that was. Is that
normal? Probably not – my first
thought last week, upon not being able to find the binder of documents my
financial advisor put together for me was “omg, what if someone stole
them”. In my defense, it’s pretty
challenging to lose track of things in a <600 sq foot studio.
It feels like a good time to take stock of my life. Next month marks some big things – one
year at my job, my 23rd birthday, and the start of my vacation to
Greece (a place I have dreamed of visiting since watching the Sisterhood of the
Traveling Pants movies). I opened
and maxed out a Roth IRA for 2011 and 2012, contributed to my 401K, and stashed
some liquid savings in my HSBC savings account. Overall, I saved 27.56% of my income from this year. Factoring in some investment growth
& a generous employer contribution to my 401K as well, it feels good to say
that I now have a net worth of (very slightly) over 30K.
I’ve been reading Malkiel’s ‘A Random Walk Down Wall Street’ –
woohoo random walks are getting the attention they deserve! Also, great book. It’s always interesting to read about
the overlap of finance and academia, and how theoretical ideas hold up in
practice. For instance –
diversification is a pretty straightforward concept. Ideally, you want a mix of different assets such that when
some go up, the others go down, and your returns are more consistent and less
volatile. We’re working to
mitigate systematic and unsystematic risk in our investments. The latter (unsystematic) covers things
that can happen to any one company – a bad investment, a corporate scandal, or
a tsunami destroying everything.
By investing in many companies, you reduce this unsystematic risk and
the likelihood that anything terrible happening in a particular company will
hit you hard.
The tricky thing, however, is that stocks tend to move in
tandem – when things are good, many stocks are up, and similarly many move down
together in a similar pattern.
This is the systemic risk – cannot be avoided by simply spreading
investments across many companies.
So people came up with a term – beta – to describe systemic risk. Essentially, you assume an index fund
covering a broad spectrum of stocks to be equal to ‘1’, and rate every other
stock by its volatility in relation to the index. So, if a stock falls only by 10% when the index drops by
20%, and similarly fluctuates less in the upward direction, it would be said to
have a beta of .5. If a stock is
twice as volatile as the index, it has a beta of 2.
It’s commonly accepted that a lever for increasing earnings
is increasing risk – the logic goes that people need to be compensated for the
greater risk by larger returns, else they will stick to the safer investments. The capital-asset pricing model (CAPM)
states that investors with a larger beta for their portfolio will have higher
returns. The funny thing is that
research has come to some different conclusions about the efficacy of this
strategy. So many theories do tend
to fall apart when you uh, apply them to reality. That amuses me.
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