“Risk comes from not knowing what you’re doing!” Warren Buffett (1930 – )
We often listen to people who hesitate to invest in the stock market because they fear risk. There are older people who fear that a stock crash could leave them destitute. There are young couples who pine for a new home but worry that an investment loss could kill their chances.
For any investor, risk is a fact of life!
Whenever an opportunity opens up for you to make an investment profit, you also face the fear of the possibility of suffering an investment loss. Even with “safe” kinds of investments, such as bank deposits, there is a risk that the rate you earn will not exceed the rate of inflation.
Often, these fears are rooted in a misunderstanding of what risk is. Those who understand market risks –and properly evaluate their ability to tolerate them– can supercharge their investment portfolios by embracing a certain amount of uncertainty!
In the financial world, risk translates to uncertainty and it’s measured by standard deviation from the norm.
Many individuals would say the riskier investment is the first, because their principal would be in greater jeopardy. But to professionals, the first investment is merely stupid –not risky–because it’s a sure thing to lose!
Still, what worries many is that you never know when the stock market is going to dive. What if it falls right before you need to sell?
Most individuals measure risk as their chance of loss, but we measure risk by the variability of returns!
In other words, because stocks have higher average returns, you can suffer some losses and still end up vastly ahead over the long run.
There’s only one situation in which adding stocks to your portfolio doesn’t make sense–when you don’t have time to let the market work for you.
In any given year, you have about a 1 in 4 chance of taking a loss in the stock market. If one year or less is as long as you plan to invest, stocks boil down to a gamble.
But if your time horizon is five years or more, there’s a very good chance that putting at least a portion of your money in stocks will boost the performance of your investments!
One question you have to resolve is the kind of investment risk you’re comfortable taking. The choice ranges from conservative to aggressive, with a broad middle ground between the extremes.
Conservative Investing: Means putting money where there’s little risk to principal.
Moderate Investing: Means taking risks by putting money into growth stocks and bonds.
Aggressive or Speculative Investing: Means taking a possible risk of losing part of your investment in exchange for the possibility of making a larger profit.
The ideal risk equalizer is that you should work for balance among the various risk categories.
One of your concerns should also be that if you invest too conservatively, you won’t have enough money down the road to afford your goals even if you’ve been diligent in following your plan.
Another concern is that by taking too many chances you risk losing too much of your capital.