Proper understanding of market risk is essential to your success as an investor. And let’s face it: whether we just want to dip our toes in the dark, murky waters of investing or are ready to dive in headfirst, we are ALL investors.
We all make choices about where to put our money. Whether it’s investing in our education, a basic savings account, or in an S&P 500 Index fund, anywhere we place money with the expectation of receiving a greater future return is an investment.
Most investing fears center on the stock market (and the bond market, but more on that another time). One day the market’s up, the next day it’s down, and we’ve all heard stories of that neighbor or relative who lost everything “in the market.”
It sounds like gambling, doesn’t it?
It IS gambling if you have no idea what you’re doing and buy shares of companies that you simply hope will do well in the future.
But investing doesn’t have to and SHOULDN’T be gambling.
Now, there is risk in ANY investment. However, this isn’t the same as saying investing is risky. What’s the difference?
Well, if you go to college you’re taking a financial risk. Not everyone graduates, and even degree-holders aren’t guaranteed high-paying, fulfilling careers. But no one would say it’s RISKY to go to college! The statistics overwhelmingly favor the investment of your money, time, and effort to earn a degree. Same thing when you get in the car to drive to work. There is always a risk of getting in an accident. But you don’t avoid modern transportation. Why? Because you understand the risk versus the reward of getting to work in a timely manner.
It’s the same thing with investing in the stock market. You simply need to understand risk in its proper context.
It IS risky to put all your money into ONE stock. It’s a prudent risk to invest into several mutual funds that give you a little bit of ownership of THOUSANDS of stocks.
Think of it this way: say you put $1000 into a total stock market index fund. That means you own a tiny piece of every publicly traded company in the United States. If ONE or even ten of those companies fails tomorrow, it’s not even a blip on the radar. For you to lose your all money, the entire US economy would have to literally collapse (and that didn’t even happen in the Great Depression).
Historically, the market has grown an average of 11.6% per year. Some years are down, some are up, but it has consistently averaged 11.6% during ANY given 20-year period. That includes wars, riots, depressions, and recessions. Compare that rate of return to a money market savings account that gets about a 1% rate of return, or a life insurance policy at 2-3%. Those rates of return are terrible!
Not to mention, there are multiple types of risk at play. We won’t get into the weeds on all the kinds of risk in this post, but suffice it to say that inflation risk, interest rate risk, and other types of investment-related risk should all factor into your investment choices.
The good thing is there are PLENTY of investment options with sensible risk to reward ratios. The point here is that taking risks in the stock market isn’t a matter of casting your lot and hoping for the best. It’s about equipping yourself with knowledge to invest the right way.
Here’s another way to look at risk: what is the risk of NOT investing?
If you stay on the path of saving and spending at your current rate, how much will you have when it’s time to retire? (And we WILL retire, whether by choice or by physical inability). Sorry to burst your bubble, but if you’re not investing in the stock market, it won’t be enough to survive.
It used to be that you’d get a job, stay with the company for 30-40 years, and retire with a pension. As long as the company didn’t go bankrupt, you were okay. For the most part, our grandparents and some of our parents didn’t have to think about investing.
But it doesn’t work like that anymore. 401Ks and Roth IRAs are putting the employee in the driver’s seat when it comes to retirement, and as higher education costs continue to rise, 529 plans are ever-more important.
We don’t have the option to put our financial futures in someone else’s hands. Even if you work with an investment advisor, YOU are ultimately in charge of your investing decisions. We don’t have the luxury of NOT educating ourselves on investing for retirement and education.
Unless you want to scrape by on government assistance, learning to invest in the stock market is non-optional. The risk of failing to invest is too great.