There Is No Such Thing As A Safe Stock

Why diversity across asset classes is a classic investment position

Do me a favor and google “safe stocks”.  Here is the link to make it easy on you.

What you see is a loaded list of terms that refer to a “safer retirement”, “protection”, “defensive”, “high yield”, and most importantly “dividends”.  All of these articles want to wrap you in a warm blanket of isolation from all of those other scary stocks that are likely to lose value at some point in time.

Similar marketing phrases that are regularly associated (either directly or indirectly) with this theme are “low volatility” and “low beta”.  Basically that means stocks that have shown minimized price fluctuations compared to a broad benchmark over the last year or so.

The connotation is that these stocks are going to be the ones that keep your wealth secure in the event we experience another crash, bear market, or fresh financial crisis.  While this may be true in some circumstances, it’s reckless to identify a specific stock or group of companies as being safe in an absolute sense.

Low volatility is not an unqualified guarantee of investment success.  It’s simply a screen for prior price action as a factor characteristic.  The same can be said for quality, dividends, momentum, size, and other measurable criteria.

The disclosure should read: This will work well during specific periods that favor the qualities of the underlying stocks we selected.  It may also underperform during periods of time that those trends become less important to stock market participants.  We don’t know when those periods will be.  Good luck!

I was an early adopter of low volatility ETFs back when they were first starting to gain some attention and assets.  I recently let go of that exposure as I witnessed them becoming overly crowded and touted as the cure-all for market downside.

I do still believe in the qualities these funds offer for conservative investors over a long time frame.  However, they are not completely immune to every feasible drop in the stock market.  It’s also worth pointing out that any downside protection they do provide is going to be done so in a relative sense.

The only absolute form of downside protection is cash.  It’s also an absolutely fantastic way to miss out on any form of growth or meaningful returns.

The lesson here is that there is no such thing as a safe stock.  There are just stocks with differentiated risk factors than other others.  Some stocks are correlated with commodity prices.  Some move with interest rates.  Some move based on earnings or business execution.  Some move for no logical reason whatsoever.

One way to help minimize those risks is to diversify across multiple sectors and asset classes.  Investment vehicles like exchange-traded funds make this process extremely easy and very low-cost.  This investment style has been proven to help smooth out your returns over various cycles.

In my opinion, investors get into trouble when they become too confident in a specific trend or correlation that has been working for quite some time.  They start to believe they found the holy grail of strategies that is immune to everything else that is going on around them.  Every strategy will eventually undergo a period of underperformance.

You simply have to understand this as part of the price of admission and avoid making irrational mistakes that can derail your progress.

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