What are investment risks?
4 min read •
30 sec brief
The key to understanding investments is understanding how much risk you would like to take with your investments.
Investing does not have to be stressful or complicated. The key is to understand the biggest risks to your success so you can then hatch a plan that will help you steer clear of those potholes.
The biggest risks are personal decisions that often feel great and smart in the here and now, but can backfire down the line.
Big Risk 1: Trying to Avoid Bear Markets.
Nobody likes the prospect – and reality – of losing money. But to be a successful investor requires accepting that your stock portfolio will have losses from time to time. If you sell stocks when things get rocky you will likely earn subpar returns over the long-term because you now have set yourself up to fall for a different risk: not being invested when the market is rising.
Between 1998 through 2018 there were more than 5,000 days when the U.S. stock market was open for business. That stretch included two big bear markets. If you were invested in stocks the entire time, you earned an average annualized return of 5.6%, according to Morningstar. If you weren’t invested in stocks for just the 10 best days among those 5,000+ trading days, your return was 2%. If you missed 20 or more of the best days for stocks your portfolio would have lost money. Running to the sidelines is dangerous. Staying in the game is how you give your portfolio the ability to deliver winning returns over the long term.
Big Risk 2: Thinking cash is a safe investment.
Cash is the best place for your savings. For example, if you have an HSA account that you intend to tap for current health care expenses, cash is the best place for that money. But if you contribute to an HSA account with the intention to leave it growing until you retire, then your focus should be on trying to earn a rate of return that at least keeps pace with inflation. Historically, the interest earned on cash hasn’t kept pace with inflation. Stocks have delivered the best inflation-beating gains.
Granted, inflation has been low for more than a decade. But even at just a low two percent annual rate, every $100 you need to pay for your living expenses today will require $164 dollars in 25 years.
Big Risk 3: Being sure you're right.
Academics who study our investment biases have reams of research showing that we tend to suffer from overconfidence, and that can make a mess of our investment process.
One of the best risk-management tools is to constantly ask yourself, “Hey, what’s the consequence if my assumption turns out to be wrong?” That can be the brake you need to tap to keep yourself from piling into a few hot stocks and choosing instead to invest in a diversified portfolio. Conversely, if your POV is more along the lines of Chicken Little and you decide not to invest, contemplating the consequence of being wrong and out of the market on its best days (see Big Risk 1) may be the nudge you take to take on a little more risk.
Big Risk 4: Waiting for a better time to invest.
When you are younger, there are plenty of claims on your dollars—making rent, the student loan payment, and yes the well-deserved vacation time –that push investing aside. Besides, you think, no worries, you will get serious about investing in your 30s or 40s. The thing is, you have one shot, in your 20s, to take full advantage of the sweetest investing strategy: compound growth. Money you invest in your 20s for retirement will have up to 50 years or so to grow. Wait until you are 40 to get serious, and you’ve cut the time compound growth can work for you down to 30 years. Another timing risk is that you have a chunk of money you want to invest – you need to invest – but you keep waiting for a better/best time to invest. Standing on the sidelines won’t get you to where you want to be. The good news is that a few key decisions can help you maneuver around the big risks.
Make investing automatic.
Set an investment plan that automatically pulls your money into an investment account is the best way to stay committed to investing. If you have a workplace retirement plan, you know how out-of-sight-out-of-mind investing becomes when your contributions are automatically taken out of your paychecks. You can create that same automation with virtually any type of investment account, such as an Individual Retirement Account (IRA) or Health Savings Account (HSA).
Use index mutual funds or ETFs for insta-diversification.
Funds and ETFs own hundreds and sometimes thousands of different stocks or bonds. That’s the solution for not betting your future on just a few stocks or bonds that end up underperforming.
Perplexed by all the fund and ETF choices? Look for a target-date fund (TDF). The target refers to the year you expect to retire. Pick a TDF that focuses on a year when you will turn 65-70 and it will hold a mix of stocks and bonds that are appropriate given your investing time horizon.
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