[Financial Planning for the 100-Year Life] How to Manage Stock Investment Risks

As the year-end and New Year passed, many financial investment companies, media outlets, and YouTube channels competed to release prediction materials related to the stock market for the new year. While looking at these materials, one question comes to mind: Is such short-term stock price prediction really possible? Many experts say it is impossible. Legendary fund managers like Warren Buffett and Peter Lynch in the United States also say that stock prices a few months ahead cannot be predicted.

"I have worked as a fund manager for the past 30 years, but when asked about this year's stock market outlook, honestly, I feel at a loss. Because I don't know." I once heard such a confession from a well-known domestic fund manager whose name alone is recognizable. Even from my own experience of over 50 years in the financial investment market, it is the same. Starting from the oil crisis and construction stock turmoil in the 1970s, I have experienced countless times when unforeseen events caused stock prices to plummet, including the IMF foreign exchange crisis, the 9/11 terrorist attacks, COVID-19, and the Ukraine war. Only after these events passed could one realize that it was impossible to know when such incidents would occur or when they would end.

Then, how should ordinary amateur investors succeed in stock investment? While it is necessary to make efforts to predict stock prices and select quality stocks with the help of experts, that alone is not enough. Alongside that, two types of risks that determine investment success must be managed: the market's overall risk and the unique risk of individual stocks.

How should the market's overall risk be managed? For short-term investments, it is impossible to manage this risk by individual effort alone. Assuming that market crashes can occur at any time, the only option is to buy stocks of good companies and patiently wait until the market downturn phase passes. In that sense, long-term investment with surplus funds is necessary.

The other risk, the "unique risk of individual stocks," refers to the risk that stock prices fluctuate due to factors unique to the company when you buy a company's stock. Unique factors include the rise and fall of the industry the company belongs to, the ability of the management, changes in demand, changes in costs such as raw materials and labor, technological progress or obsolescence, and regulations related to the industry. Influenced by these factors, the stock price of the company may move differently from the overall market trend. Investigating these factors and buying undervalued stocks relative to the company's fundamentals is the basis of stock investment.

To manage individual stock risk, the basic task is to try to select good companies whose stock prices are undervalued compared to their fundamentals. However, no matter how much effort is made, it is impossible to defend against individual stock risk 100% unless one is a deity. This is because the variables that move stock prices are extremely complex and diverse. Therefore, individual stock risk must be managed through diversification. Diversification means spreading investments across several to several dozen stocks to reduce investment risk.

For example, suppose you invested in airline company stocks. The airline company's profits are influenced by various factors, but the biggest influence is the trend of oil prices. When oil prices rise, fuel costs increase, reducing airline profits and causing stock prices to fall. However, if you had also invested in oil company stocks at that time, even if airline stocks fell, oil company stocks would rise due to the increase in crude oil prices. Investing in both stocks reduces investment risk significantly compared to investing in only one.

This is the effect of diversification. Fund managers invest in 20 to 30 stocks in a single equity fund precisely with this diversification effect in mind. While diversification among stock stocks is important, it is even more important to diversify investments across assets with different risk levels, such as stocks (equity funds), bonds (bond funds), and CMA. For successful investment, considering your own circumstances such as age, financial status, family situation, investment temperament, and investment period, you should determine the diversification ratio between aggressive and stable investment products before starting to invest.

Kang Changhee, Representative of the Happy 100-Year Asset Management Research Association

This content was produced with the assistance of AI translation services.