Wednesday, August 24, 2011

Penny Stock Q&A: Young people taking more risk on their investment?

Question by James : Young people taking more risk on their investment?
Im 18 years old, turning 19 in December. Going to college for a Finance degree. I want to become a Financial Analyst and a Investor on the side. I?m currently not investing, but the question i have is what should be a young person first investment move? Everyone says young people should take on more risk for their portfolio, does that mean invest in penny stocks? I understand every investment even blue chips come with risk, But how much risk should a 18 year old take? Im guessing the first investment move would be, save up 6 months of savings just in case anything happens. Then what would be a good next move?

Best answer:

Answer by The Son of Rage and Love
Being young might mean taking a little more risk in your portfolio but it doesn?t mean being foolish. Penny stocks are the worst place for an inexperienced investor to start. The information on the companies is much sparser and unreliable, so penny stocks are so speculative they are more gambling than investing. So you start out with investments that teach you the complete opposite of the discipline you need to invest. There are plenty of speculative, good stocks that are traded on NASDAQ, not the pink sheets.

Answer by J
younger people can afford to take more risk if their goal is investing for retirement because they have time to weather the ups and downs of the market. Investing has nothing to do with age per se it has to do with how long a period are you investing for and what is your risk tolerance.

Risk tolerance is hard for people to understand. People thought they were investing to fit their risk tolerance but found out when the market tanked that they risked their retirement and made panic moves that often made the situation worse. Even if you diversify your investments you have to expect at some time for your equity portion to drop 50% or so. It is not a macho thing but a comfort thing ? what percent of your equity assets can you afford to see drop 50% or more? Remember just because you can afford to take more risk doesn?t mean you should. How many millionaire athletes could live comfortably for the rest of their life only to blow their assets on stupid purchases and unwise investments.

You want to diversify your investments to get the best balance of growth and risk. I suggest reading the Boglehead?s Guide to Investments as a start. If you want to start investing then go small at first to judge your tolerance for risk. The Vanguard Star Fund is where I started my daughters. It has an initial investment of $ 1000 and invests in large, small and foreign stocks and bonds.

Educate yourself first and ignore the media hype.

Good Luck

Answer by John W
The concept of being aggressive while young has been taken to excess in terms of investment. Many 401k?s offer a 100% growth stock ultra-aggressive portfolio for the young but that is probably the last portfolio that you would want. The young have the most time to recover from a setback but they also have the highest probability of encountering a market crash such as the one we?ve just experienced that would wipe out an aggressive position. To illustrate, imagine if you had a weighted coin that flipped head 95% of the time, how much would you wager with each bet, if you wager everything you have, you?d surely gain the most but if you wagered everything you had with each flip, you?re guaranteeing that you will lose everything. It?s the concept of optimizing the geometric mean of outcomes first published by Bernoulli as the solution to the St. Petersburg Paradox. It?s also known as he G-policy the Maximised Expectation of Logarithms, Capital Growth Criterion and The Kelly Criterion. Basically the probabilities and the expected outcomes will determine how much of your portfolio to risk. Indeed all else being random, rebalancing a 50/50 portfolio is the optimal growth path. As it happens, the stock market has a general trend upwards so far less of your portfolio need to be cash or cash equivalents but to have no cash or cash equivalents means that you cannot benefit from a market downturn and effectively any gains you may have stands to be wiped out at any time.

Penny stocks is a fools errand. It?s true that a price move on a penny stock can mean a large percentage of your investment but the same degree of leverage can be obtained with options. A call option (option to buy) has an intrinsic value equal to the difference between the stock price and the option?s strike price when the stock price is above the strike. There is also an extrinsic time decay value due to speculation as to whether the stock will go up or down before the options expiration. Ignoring the extrinsic value component which decays away with time and as the stock price moves away from the strike price, the option will have the same price movements as the stock but trades for far less, pennies if it?s near expiration or if the strike price is near or below the stock price. The end effect is that call options have all the advantages of a penny stock with few disadvantages and less risk. Also options due to their non-linear relationship with the stock price (call options are linearly proportional to stock price when the stock price is above the strike but intrinsically worthless when it?s below, put options are inversely proportional when the stock price is below the strike and intrinsically worthless when above), combinations of options can be used to cancel out risk entirely. For example, a put and a call option with the same strike at the current stock price will make money regardless of whether the stock price goes up or down so long as it does go up or down before expiration. Shorting a put and a call guarantees a profit if the stock price remains within certain bounds. Holding the stock, shorting an overpriced call (all options are technically overpriced due to the speculative extrinsic value) and purchasing an out of the money and holding till the shorts are close to expiration put can result in a guaranteed profit regardless of stock price etc. There are literally better options than penny stocks for that kind of return.

To a certain extent you need to quantify risk. So far you?re just thinking in general terms such as penny stocks being riskier. But what about volatility? How does volatility affect the expectation that a stock price will change by at certain amount within a given timeframe? What about mean variance? Is volatility an opportunity or something to be avoided? Why?

Your best move would be to read a few books, I would start with easy to read books like ?Take Your Money and Run? by Alex Doulis and ?Fortune?s Formula? by William Poundstone and then ?Beat The Market? by Ed Thorp (read it online, Amazon?s price is absurd) and ?The Intelligent Investor? by Ben Graham. After that, read the ?Wizards of Wallstreet? series of interviews.

Answer by zuma
For those that were 18yrs old, 10 years ago, taking more ..Risk..didn?t pay off, if they were ?Buy and Hold??

http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=S+P500&sid=&o_symb=S+P500&freq=2&time=13

Traders ..may have left profits on the table.

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