Some people shy away from investing because it involves risk. What they really mean is that they fear that they will lose money if they invest. But if you demand a guarantee that the value of your principal will not fluctuate, you will generally have to be satisfied with a return that may not keep pace with inflation—and that’s risky, too. No matter what you do, you can’t avoid risk. But you may find it easier to accept the risks associated with investing if you understand them.
Where does risk come from?
When you invest in the stock market, your principal is likely to fluctuate in value because stock prices are set by investors who bid in an open market. Investors form their opinions about stocks, in general, and individual companies, in particular, based on a variety of factors: a change in profitability, a shift in the economy or the direction of interest rates can affect stock prices from one day to the next. If you picture the stock market as a series of one-year returns, they would range from –43% to +53%. Yet, the stock market has also generated the highest average long-term return of any asset class—+10.4%.
Bonds can also fluctuate in value if they are traded instead of being held to maturity. The bond market has historically been less volatile than the stock market—its lows have not been as low and its highs not as high. Therefore most segments of the bond market are considered less risky than stocks.
Investigate risk
Before you choose an investment, ask your financial professional to talk to you about its potential risks. Ask yourself whether your time horizon is a match with the investment. Then, consider your comfort level with the range of possible returns you could experience.
And think about this: Despite wars, recessions, assassinations and political unrest, the U.S. stock market has tracked an upward course for more than 100 years. If you take a short-term approach to investing, you are likely to be disappointed. But time is on your side when you invest for the long term. Time smoothes the ups and downs of the market and rewards investors with the patience to ride out volatility.