As is the case with many activities, there are different styles of investing. Some investors are gung-ho, reading stock reports like other people read spy thrillers, tracking the market from opening until closing, analyzing their portfolios on a daily basis, and checking with their brokers frequently. Others prefer to stand back and watch from a distance, depending on their brokers to steer them through, and hoping that the ups and downs will eventually result in gains and they’ll reap the rewards of the stock market.

In this chapter, we’ll look at some different styles of investing. As we do, try to figure out where you best fit in, as your style of investing will affect the types of stock you buy and other factors.

Some investors tolerate or even welcome high risk, while others shy away from it, willing to accept lower returns for the ability to sleep at night. It’s very important to understand that in the stock market risk and reward are always linked. Higher-risk investments have the capacity to yield higher reward than lower-risk investments. It’s that simple. Your job is to figure out how much risk you’re willing to tolerate, and then match that with the investment.

The characteristics of risk tolerance and time willingness are instrumental in determining your investing style. Risk tolerance is simply how much risk an investor is willing to assume. It is usually based on factors such as your time horizon, or how much time you can allot to investing before you’ll need to start collecting on your investments. Younger investors tend to be more risk tolerant than older investors—although, of course, there are exceptions. Time willingness is how much time the investor is willing or able to devote to the investing process and tending to investments.

When you think about it, people tolerate different levels of risk in many different situations, including driving, sporting endeavors, and lifestyle choices. Some people are just more naturally cautious than others, and that includes investors. Some researchers believe that genetics at least partially determines how different people invest their money.

Researchers at Claremont-McKenna College in California believe that genetics help to determine how much tolerance for risk people have, including with their investments. Two professors studied the investment records of almost 35,000 identical twins in Sweden, and found that their investment styles regarding risk were eerily similar, even if they hadn’t been raised in the same households.

Generally, we lump investors into three categories: high risk, moderate risk, and conservative or low risk. Let’s take a look at some of the characteristics of each of these types.

Many people are inadvertent high-risk investors because they aren’t sufficiently prepared when they enter the stock market and therefore make unnecessary mistakes that put their investments at risk.

Others, however, are intentionally risky with their investments. A check on the web will turn up all sorts of groups and opportunities for high-risk investors. Some investors seek out high-risk stock, willing to gamble on big returns. Often they act on tips and buy and sell stock quickly in order to realize profits. While this is called high-risk investing, it really is speculation, and generally not a good idea. If you are interested in a higher-risk investment, make sure to commit only a small portion of your holdings. Five to 7 percent of a portfolio in high-risk investments is all an investor should consider until his wealth is enough to sustain him through retirement.

There are many different definitions for a high-risk investor, but it’s generally considered to be someone who can live with losing one quarter of his or her investment portfolio within a year’s time.

Angel investors are individuals or groups that seek out promising startup businesses and invest in them, betting on high returns as the company grows. These high-risk investors are great news for entrepreneurs as it’s estimated they contribute between $20 million and $50 million a year to young businesses—with a lot of stipulations, of course.

Moderate-risk investors are those who are willing to include some riskier stocks in their portfolios, but make sure that they’re balanced by conservative investments. A moderate-risk investor is generally defined as someone who can stand the thought of losing 15 percent of his or her portfolio in a year.

Conservative investors, like all investors, want to see their net worth increase, but they want to do that without risking any of their principal. That’s a perfectly sensible ambition but can be limiting in that, without assuming any risk, you limit the rate of return you can expect.

Conservative investors, also known as risk-averse investors, often look to park their money in places other than the stock market. They might employ money market accounts or buy government bonds. Those who do jump into the stock market typically buy the stock of old, established companies.

You already know that investing in the stock market involves risk. There is no fool-proof formula that can guarantee you’ll never lose any money. The trick is to minimize your risk, and there are various means for doing that.

When you invest in the market, you’re exposing yourself to two very general types of risk (and lots of other kinds of risk that you’ll read about in a bit). The first is the risk that your investment will decrease in value—that’s called investment risk. The second is personal risk, and that is how a decrease in your investment would affect you and your life.

If you don’t need the money you’ve invested, it doesn’t really matter if your investment portfolio loses half its value. It might be annoying, but it would have little or no effect on your life. If, on the other hand, your plans for buying a seaside cottage in which to spend your retirement years goes down the tubes along with your investment portfolio, that’s big trouble as a result of personal risk.

Now let’s take a look at some of the types of risk that can affect the stock market—and your portfolio. Some types of risk affect the entire market, and they’re called systematic risks. Risk that affects only a certain portion of the market, such as a particular business or industry, is called unsystematic risk.

Business risk is easy to understand. It’s all about how the company in which you’ve invested is managed. Does it have a marketable product and a good management team that knows how to get that product to market? Is the business profitable? Will the market for its product continue to grow? If the answer to any of these questions is “no,” the chances of your investment giving you a good return are not all that great. You minimize business risk by being diligent about investigating a business before you buy its stock. You’ll read all about how to do that in Part 3.

Financial risk is directly linked to business risk, since the way in which a business is managed directly affects its financial situation. Financial risk is the risk that your investment will lose value because the company loses money, or worse yet, goes bankrupt.

A great example of financial risk was seen in September 2008, when the giant financial company Lehman Brothers filed for bankruptcy, sending share prices tumbling more than 95 percent. Lehman shareholders who had felt good about investing in a huge, established firm experienced financial risk firsthand, with major losses for many.

Looking back, we can see there were many indications that Lehman Brothers was in serious trouble, although it worked hard to avoid the appearance of that reality. Again, it’s not only important to research a company before you buy its stock, but to keep up with the goings on of the company once you own it.

Interest rate risk is the risk that the value of an investment will change due to a shift in interest rates. Generally, interest rate risk affects bonds more than stocks, because when interest rates rise, bond prices fall. When interest rates fall, however, bond prices rise.

Stock investments, while less dramatically affected, are not immune to interest rate risk. Dividend-paying stocks may be drastically affected by rising interest rates. Rising interest rates have negatively affected stock prices in the past, and there’s no guarantee that, if we experience a significant rise in rates in the future, they won’t be negatively impacted again. If a company has a high level of debt and has to pay more interest on that debt, its profitability will decrease. High interest rates can also hinder a company’s plans for expansion, thereby limiting its growth.

Changes in interest rates tend to affect some industries more than others. Generally, real estate, the financial industry, and utilities are affected most by interest rates, as rates both rise and fall. When you’re thinking about buying stock, keep an eye on what’s going on with interest rates and consider how the company you’re considering might be affected if rates are changing.

Market risk reflects the tendency for stock to move with the market. You frequently hear people talking about the market as though it’s one giant stock, when, in fact, it’s millions of stockholders holding millions and millions of shares of stock. And, as you read in Chapter 1, the value of stock always comes back to supply and demand. If demand for a stock you own increases, its price will rise. If nobody wants it, the price will go down. Thus, the market, and segments within the market, rise and fall in value.

Market risk is not easy to control, but diversifying your portfolio through asset allocation can help. You’ll read more about that later in the chapter.

Purchasing power risk is the risk that inflation has on the value of your holding. If you earn 8 percent a year on a $10,000 investment, you’d earn $8,000 over 10 years, plus the value of your original investment. If high inflation occurs during that 10-year period, however, your $18,000 (due to the time value of money) will be worth considerably less than the value of $18,000 at the time you made the investment. Inflation is a negative factor in that it causes buyers to purchase in the present because they fear the purchase will only be more expensive tomorrow. On the other hand, deflation prevents the consumer from buying in the present because he believes the item will be “on sale,” or cheaper tomorrow.

Some businesses and industries are subject to risks that are unique or inherent to them. The airline industry, for instance, is subject to the risk of plane crashes, which definitely affects its bottom line. The food industry is subject to product recalls, such as the massive 2010 egg recall because of salmonella concerns. The oil industry faces risk in the form of leaks that result in environmental disasters (think BP), and so on. You can minimize exposure to industry risk by considering the likelihood of risk before investing.

Some of the risks we’ve just discussed are more controllable than others. Business risk, for example, is easier to control than market risk. If a company is not performing well, the board of directors can make changes in management and policy. A declining market due to generalized anxiety over the economy, however, is harder to control.

Some risks are uncontrollable. A natural disaster that destroys a company or affects an entire industry is an uncontrollable risk. Acts of terrorism can affect the market in general, as we saw after 9/11, and certain industries such as the airline industry in particular. These risks are difficult or impossible to anticipate, but again, having a diversified portfolio and remaining alert and nimble in how you respond to such events can make it more likely that your portfolio will survive.

Asset allocation is simply the process of deciding where to invest your money. Most financial advisors will tell you it’s better to have your investments divided between different families of assets. That way, if one aspect of your portfolio is doing poorly, another part can keep you afloat until the ailing portion recovers.

In a healthy portfolio, funds are divided between investment vehicles such as stocks, bonds, real estate, precious metals, treasury securities, and cash. Although this book concentrates on stock market investing, I’d never advise that every dollar you have to invest should be tied up in the stock market.

Having your money spread out across a variety of investment vehicles helps to protect your investment, even if one aspect of it suffers. Stocks and bonds are the classic example of the benefits of asset allocation. That’s because, when bond yields are low, investors get fed up and start buying stocks. The influx of buyers into the stock market causes stock prices to rise. When the stock market gets into trouble, investors seek out the security of the bond market and give it a boost, as evidenced by the historic influx of money into bond mutual funds in 2010.

Your goal should also be diversification within the stock market. You shouldn’t put all your money into stocks from one company, or even one industry, no matter how well you understand a sector of the market. The fact that you’ve been working in the health-care industry for 20 years in no way guarantees you’ll do well financially by investing all your money in health care–related stock. If all your money is tied up in oil stocks and somebody comes up with a new technology for a great car that runs on oxygen and costs $500, you’re going to be really sorry you didn’t diversify your portfolio.

Many investors found out the hard way in the early 2000s that it wasn’t a good idea to invest all their money in Internet and technology stock. A great deal of money was lost when the dotcom bubble burst in 2000. It’s recommended that your investments include stock of companies in at least four or five different industries.

Along the same lines, if you simply love a particular company and have all your money invested in its stock, you’re going to be very unhappy if that company should fail. Most advisers recommend that you invest no more than 10 percent of your money in any one company.

Some people love to check up on their investments, while others pretty much ignore them until a statement shows up in the mail or online. The amount of attention you give to your investment portfolio is another piece in determining your investment style.

Of course, some people have more time to spend monitoring the ups and downs of the stock market than others, and some people are simply more interested in what’s going on than others. You should decide what makes sense for you in terms of time spent monitoring your investments, and what your comfort level is. Some investors are perfectly comfortable going for weeks without checking in, while others feel the need to view their accounts every day.

If the market is volatile, keeping a close eye on your investment portfolio can be a full-time job—not to mention a wild ride. Let’s face it: obsessing over your portfolio during a bear market can be downright depressing. It’s not easy to watch your net worth decreasing, month after month. On the other hand, it’s darned exciting to watch your Apple stock shoot up by 8 percentage points in one day!

People who are in the stock market with the intention of buying and selling stocks on a very short-term basis must pay much greater attention to it than investors who are in for the long haul and willing to wait through the highs and lows in hopes of substantial returns down the road. Sometimes, though, investors with no thought of daily trading feel the need to keep up to date with every move their portfolio makes.

A risk of that daily or near daily scrutiny of your stock portfolio is that you’re more likely to feel compelled to buy or sell in reaction to what you see occurring, even if you didn’t intend to. Many of us have a difficult time remaining calm and not reacting to market fluctuations. On the other hand, keeping a close eye on your portfolio gives you a better chance of catching any unauthorized trades or mistakes that might have occurred.

If you invest online, you can have alerts tied to your account to notify you when one of your stocks hits a 52-week high or drops 8 or 10 percent below the purchase price. Alerts can advise you of company statements or news about one of your stocks. This kind of information is helpful and can be exciting, but can also be distressful in a down market.

You wouldn’t have invested in a particular company if you felt that you were going to lose money. After a few years, investors forget their fear of a market decline. The psychology of investing for most people is that they abhor a loss of 10 percent much more than they enjoy a gain of 20 percent. That’s because they consider that a gain is a given. You wouldn’t (at least you shouldn’t) invest in a stock if you didn’t anticipate that it was going to go up, so when it does, it’s what you expected.

The flip side to obsessively checking on a portfolio is ignoring it, or just glancing at statements as they come in. At the very least, you should examine monthly statements to make sure there is no activity that you haven’t authorized, and that any activity you have authorized has been recorded.

There’s a good middle ground between feeling that you have to track every movement of your portfolio and ignoring it to the point where it’s irresponsible. You’ll need to determine where that middle ground is for you.

How involved you want to be in the day-to-day management of your investment portfolio is up to you. You could opt for a full-service broker or discretionary investment advisor who will help you oversee your accounts and take much of that task off your hands. Or you can do it yourself, putting in as much time as you deem necessary.

It’s important to understand, however, that you should expect the process of preparing to enter the stock market to be somewhat time-consuming. You’ll have to learn the language of the market, figure out how to read market reports, research companies before you buy stock, learn to read financial reports, and address other issues associated with investing. And once you’re in the market, you’ll need to take time to keep up with financial news, stay abreast of general market conditions, and maintain an understanding of general economic conditions.

That’s not to say that by the time you buy your first stock you’ll be an expert, and you should expect to keep learning and expanding your knowledge over the years as you track your investments and adjust them as your lifestyle changes. Wall Street seems to come up with new products and investments almost daily, and it’s likely that some of them may be right for you. Some people set aside an hour or two a week to review their portfolios and research companies that they’ve heard or read about and think they might be interested in their stock. Others check in with their brokers on a monthly basis to discuss their accounts.

Your level of involvement in your investment portfolio is a personal decision, but keep in mind that it’s your money invested and, ultimately, you’re responsible for whether or not your investments are successful.

The Least You Need to Know