Free stock software downloads and resources

Start lowering your risk with a stock portfolio. The obvious way to lower your risk to is to hold more than one stock. Suppose one of these was a company on Earth that makes socks. The other stock you own is for a company on the planet Bok in the constellation Xeka. They make socks too but for hands, feet, and their 100 other appendages as well. So you've got sock stock and bok stock (sounds a bit like Dr. Suess). The sock stock price goes up and down depending on various factors, but suppose it's controlled by if sandals are in fashion. That's bad news for socks. It's the same situation with Bok sock stock, but the fashions on the two planets are totally uncorrelated.

If you expect a rate of return of 10% on sock stock per year, this will in reality be 10% plus or minus 28%. So you could easily lose 18% one year and gain 38% the next. Suppose the same is true on Bok. If you hold equal amounts of Bok stock and sock stock then what's your rate of return? Exactly the same, 10%. The only difference is that now, the volatility has been reduced by the square root of 2. So now you're making 10% plus or minus 20%. That means you could easily lose 10% some years and gain 30% some other year. Most people will think that this decrease in volatility is a good thing.

Of course stocks on Earth aren't so independent. But that can also be a good thing. As we mentioned above, socks falling on hard times mean that sandals are doing really well (at least in our fantasy fashion world). So you could lower your risk even more if you invested in sock stock and sandal stock. That way when sandals were out and socks were in, you got the upside of the sandals and vice versa when socks were in. (We won't talk about crocs stock because that would complicate things and make our tongues fall off.)

So investing in two completely uncorrelated stocks lowers your risk by √2. If you invested in 100 completely uncorrelated stocks, you'd lower your risk by the square root of 100, or a factor of 10. So your risk instead of being 28% goes down to about 3%. That most of us can live with.

The problem is that stocks are not uncorrelated like that. They tend to be quite correlated. With the dot com bubble, most high tech stocks tended to track each other pretty well. Investing in similar stocks like a company that makes acrylic socks and one that makes cotton socks, is likely not to lower you risk very much, whereas investing in socks, and also in dvd players is likely to do a better job of lowering your risk.

The software available on this site allows you to educate yourself as to the correlations you see among different stocks. You can come up with the idea of a "distance" between different stocks. And use that to graphically represent a tree of relatedness of among them. So, you can start lowering your risk with a stock portfolio of less similar stocks.