Stock Market Dangers ©2016
There are a lot of so called experts out there who seem to think that investing in the stock market will help your financial portfolio. Let me tell you they could not be more wrong if they tried to be. With the stock markets going up and down so often and also not knowing #1. when is the best time to sell your stock and when to hold on to it. And #2. Who can you trust to give you the right advice on when is the best time to sell it and when should you hold on to it. Your like a deer caught in the headlights and that is not where you want to be because in the end no matter if you try and sell it yourself or try and find somebody to help you sell it (Your stock(s). The chances of you loosing more
five main disadvantages to owning stocks.
There are five main disadvantages to owning stocks.
1.Could lose your entire investment. If a company does poorly, investors will sell, sending the stock price plummeting. When you sell, you will lose your initial investment. The only consolation is that your will get an income tax break if you lose money. Unfortunately, you also have to pay taxes if you make money. See Capital Gains Tax.
2.Paid last if the company goes broke. Preferred stockholders and bondholders get paid first.
3.Requires a lot of time. You've got to research each and every company to determine how profitable you think it will be before you buy stock. You've got to learn how to read financial statements and annual reports, and follow your company's developments in the news. You've also got to monitor the stock market itself, as even the best company's price will fall in a market correction, a market crash or bear market.
4.Emotional rollercoaster. Stock prices rise and fall every second. Individuals have the tendency to buy high, out of greed, and sell low, out of fear.
5.Compete against professionals. Institutional investors and traders have more time and knowledge to invest. Find out how to gain an advantage as an Individual Investor.
The first risk to the stock market, is a change in U.S. interest rate policy. There is hardly any doubt that the stock market has taken its cues from the Federal Reserve. The Fed has obviously provided liquidity and zero interest rates for six years now. This has engendered a feeling that the Fed was in control and that the Fed was keen to provide an environment for financial risk taking. Many risks have been taken!
In addition to providing confidence in markets and a feeling of “risk on,” zero interest rates have allowed stocks to be valued at higher levels. Should interest rates move higher, it would make discounting future cash flows more expensive. That means stocks may not deserve their currently high valuations if interest rates are to rise materially in the near term.
Related to monetary policy and interest rates, many commentators have argued that the key thing, maybe the only thing, underpinning the huge stock market gains over the past six years has been monetary policy. Even if this is not entirely the case, the fact of the matter is that investors are highly paranoid over changes in interest rates. Investors are still very wedded to central bank support. A change in interest rates could signal the end of an era for stocks, a less dynamic Fed or a Fed that does not seem omnipotent or credible enough to push back on world bond markets if needed.
The second risk to stocks is deteriorating geopolitics. Generally speaking, geopolitics is viewed as a less visible risk than other potential market risks and therefore may have an outsized effect. Some conflagrations are known and burning hot such as ISIS/ISIL taking over much of Iraq and doing battle in Syria. Other geopolitical situations fly under the media radar such as the incredibly emotional battle between China, Japan, Philippines, Malaysia and Vietnam over the Spratly Islands. Should China and Japan ever start shooting at each other it would be very difficult for the markets to ignore a potentially catastrophic event or a massive arms race. Want To Retire In Your 30s And Travel The World? This Woman Did
Northwestern MutualVoice: You Can Teach Yourself To Be An Entrepreneur: One Woman's Path To Business Success
Perhaps a better example of geopolitical or exogenous risk is what happened in last year when world markets obsessed over Ebola for several weeks (chart above). Stocks lost almost 10% of their value and volatility spiked. Ebola, like many geopolitical events, was in many respects unpredictable and therefore scary to markets. Being at least conscious of the latest developments in world hot spots should be high on investor check lists. That does not mean that investors should be biased towards negative outcomes or become paranoid of political developments. Rather, it means taking a realistic view of geopolitical probabilities, most of which remain admittedly unlikely.
The third risk to the stock market is a poor corporate earnings season. Without a doubt, the aggregate level of corporate earnings is coming down. The worst earnings will once again come from the energy sector and related companies as a direct effect of lower crude oil prices. Take out the negative earnings for the energy sector and profits for the S&P 500 are still expected to be anemic by recent standards.
Perhaps a better example of geopolitical or exogenous risk is what happened in last year when world markets obsessed over Ebola for several weeks (chart above). Stocks lost almost 10% of their value and volatility spiked. Ebola, like many geopolitical events, was in many respects unpredictable and therefore scary to markets. Being at least conscious of the latest developments in world hot spots should be high on investor check lists. That does not mean that investors should be biased towards negative outcomes or become paranoid of political developments. Rather, it means taking a realistic view of geopolitical probabilities, most of which remain admittedly unlikely.
The third risk to the stock market is a poor corporate earnings season. Without a doubt, the aggregate level of corporate earnings is coming down. The worst earnings will once again come from the energy sector and related companies as a direct effect of lower crude oil prices. Take out the negative earnings for the energy sector and profits for the S&P 500 are still expected to be anemic by recent standards.
Beyond lower levels of earnings, analysts are also expecting negative rates of revenue growth. Including the energy sector, the S&P 500 is not anticipated to have positive revenue growth until the end of 2015. The question is whether that revenue growth will be too little, too late. These forecasts for earnings and revenues are in direct opposition to what is being forecast for margins – that they will continue to trend higher. Some skepticism over whether U.S. companies will continue to grow margins in light of very low levels of profitability and lacking revenues is due. This idea needs special consideration now that the U.S. Dollar has strengthened significantly from its levels just one year ago.
The fourth risk to the stocks is a big problem in China. The Chinese economy has slowed over the last several years but rampant speculation has switched from real estate investments to stocks in mainland China. With recent regulatory changes, many retail investors have piled into Chinese stocks pushing the index to recent all-time highs.
The point is not that Chinese stocks are/are not overvalued, a good/bad investment, or in a bubble/not a bubble. The point is that there is a very significant risk that Chinese stocks will lose value very quickly even if only temporarily. Should that happen, it will have a very negative effect on U.S. stocks as investors sell their winners (U.S. stocks) to pay for their losers (Chinese stocks). In addition, risk taking would be curtailed at many financial institutions probably resulting in much tighter risk management policies. Chinese authorities are very cognizant of these issues and seem to view them through the lens of societal unrest. The People’s Bank of China and the politburo has implemented many new support structures to prevent a rapid selloff. So far these schemes have worked, but they have not prevented huge amounts of volatility. Financial systemic volatility is the real risk from Chinese stocks.
The fifth risk to the stock market is an unexpected default by Puerto Rico on their municipal debt. Last week, Governor Padilla, stated that Puerto Rico cannot pay its debts. Up and until last week, the idea that the general obligation bonds of Puerto Rico would be supported was the most commonly supported investment theme relating to Puerto Rico. That may all be changing and it’s another thing that may add to a risk off environment for stocks.
In crude terms, many retail investors have much more exposure to Puerto Rican bonds than they probably bargained for or know about. Because the bonds of Puerto Rico are “triple tax free” – no state, Federal or local income taxes – they have been very popular investments for municipal bond fund managers who desperately need higher yielding bonds in an environment of extremely low interest rates. Most people don’t consider their municipal investments as high risk capital. That is, investments in municipal bond funds tend to be made for capital preservation and income reasons. If retail investors start to see significant losses in their “safe” bond funds, hitting the sell button across portfolios is not hard to envision. In addition, there are many hedge funds that have loaded up on Puerto Rican debt. Should these funds become forced sellers there is a high likelihood stocks will also see random selling pressures.
The sixth risk to stocks is a Greek default or a Greek exit from the Euro or European Union. The current situation in Greece is very fluid with multiple and competing political, economic and structural agendas. So far the market seems to believe that the price of a Greek exit from the Euro is calculable and affordable. Investors have been reassured that although a Greek default or exit will be painful, it doesn’t present a systemic risk like bank failings à la Lehman Brothers.
The Greeks have voted “no” on the existing bailout proposals by the Troika of the European Central Bank, European Union and the International Monetary fund and have declined to pay the interest due on IMF loans. The market’s reaction so far has been slightly blasé, although probably correct. Stocks have lost several percentage points of value but real and painful volatility has not pervaded markets. The genuine impact of a Greek default or exit may still be felt as the Greeks are liable for over €3.4 billion in payments to the ECB on July 20th. With the ECB the only institution keeping the Greeks out of a humanitarian crisis via emergency lending, ignoring a Greek default or exit is folly. Where does this leave U.S. equity market participants? It leaves them in a market that is at least “fairly valued” by traditional P/E metrics, paranoid that Fed policy has been the sole driver of gains, and waiting for U.S. economic growth to catch up to stock valuations. It is a scenario very similar to last year. The real differentiator may be the strength of the U.S. Dollar and declining corporate earnings and sales. Still, all six of the enumerated risks could easily be overcome by a “low-flation” plus growth scenario in the U.S. The combination of higher capital expenditures by corporations, more efficient regulation and fiscal policy may all support domestic growth companies making outsized risks seem improbable in the near term. Knowing and understanding obvious risks never hurts though.
five main disadvantages to owning stocks.
There are five main disadvantages to owning stocks.
1.Could lose your entire investment. If a company does poorly, investors will sell, sending the stock price plummeting. When you sell, you will lose your initial investment. The only consolation is that your will get an income tax break if you lose money. Unfortunately, you also have to pay taxes if you make money. See Capital Gains Tax.
2.Paid last if the company goes broke. Preferred stockholders and bondholders get paid first.
3.Requires a lot of time. You've got to research each and every company to determine how profitable you think it will be before you buy stock. You've got to learn how to read financial statements and annual reports, and follow your company's developments in the news. You've also got to monitor the stock market itself, as even the best company's price will fall in a market correction, a market crash or bear market.
4.Emotional rollercoaster. Stock prices rise and fall every second. Individuals have the tendency to buy high, out of greed, and sell low, out of fear.
5.Compete against professionals. Institutional investors and traders have more time and knowledge to invest. Find out how to gain an advantage as an Individual Investor.
The first risk to the stock market, is a change in U.S. interest rate policy. There is hardly any doubt that the stock market has taken its cues from the Federal Reserve. The Fed has obviously provided liquidity and zero interest rates for six years now. This has engendered a feeling that the Fed was in control and that the Fed was keen to provide an environment for financial risk taking. Many risks have been taken!
In addition to providing confidence in markets and a feeling of “risk on,” zero interest rates have allowed stocks to be valued at higher levels. Should interest rates move higher, it would make discounting future cash flows more expensive. That means stocks may not deserve their currently high valuations if interest rates are to rise materially in the near term.
Related to monetary policy and interest rates, many commentators have argued that the key thing, maybe the only thing, underpinning the huge stock market gains over the past six years has been monetary policy. Even if this is not entirely the case, the fact of the matter is that investors are highly paranoid over changes in interest rates. Investors are still very wedded to central bank support. A change in interest rates could signal the end of an era for stocks, a less dynamic Fed or a Fed that does not seem omnipotent or credible enough to push back on world bond markets if needed.
The second risk to stocks is deteriorating geopolitics. Generally speaking, geopolitics is viewed as a less visible risk than other potential market risks and therefore may have an outsized effect. Some conflagrations are known and burning hot such as ISIS/ISIL taking over much of Iraq and doing battle in Syria. Other geopolitical situations fly under the media radar such as the incredibly emotional battle between China, Japan, Philippines, Malaysia and Vietnam over the Spratly Islands. Should China and Japan ever start shooting at each other it would be very difficult for the markets to ignore a potentially catastrophic event or a massive arms race. Want To Retire In Your 30s And Travel The World? This Woman Did
Northwestern MutualVoice: You Can Teach Yourself To Be An Entrepreneur: One Woman's Path To Business Success
Perhaps a better example of geopolitical or exogenous risk is what happened in last year when world markets obsessed over Ebola for several weeks (chart above). Stocks lost almost 10% of their value and volatility spiked. Ebola, like many geopolitical events, was in many respects unpredictable and therefore scary to markets. Being at least conscious of the latest developments in world hot spots should be high on investor check lists. That does not mean that investors should be biased towards negative outcomes or become paranoid of political developments. Rather, it means taking a realistic view of geopolitical probabilities, most of which remain admittedly unlikely.
The third risk to the stock market is a poor corporate earnings season. Without a doubt, the aggregate level of corporate earnings is coming down. The worst earnings will once again come from the energy sector and related companies as a direct effect of lower crude oil prices. Take out the negative earnings for the energy sector and profits for the S&P 500 are still expected to be anemic by recent standards.
Perhaps a better example of geopolitical or exogenous risk is what happened in last year when world markets obsessed over Ebola for several weeks (chart above). Stocks lost almost 10% of their value and volatility spiked. Ebola, like many geopolitical events, was in many respects unpredictable and therefore scary to markets. Being at least conscious of the latest developments in world hot spots should be high on investor check lists. That does not mean that investors should be biased towards negative outcomes or become paranoid of political developments. Rather, it means taking a realistic view of geopolitical probabilities, most of which remain admittedly unlikely.
The third risk to the stock market is a poor corporate earnings season. Without a doubt, the aggregate level of corporate earnings is coming down. The worst earnings will once again come from the energy sector and related companies as a direct effect of lower crude oil prices. Take out the negative earnings for the energy sector and profits for the S&P 500 are still expected to be anemic by recent standards.
Beyond lower levels of earnings, analysts are also expecting negative rates of revenue growth. Including the energy sector, the S&P 500 is not anticipated to have positive revenue growth until the end of 2015. The question is whether that revenue growth will be too little, too late. These forecasts for earnings and revenues are in direct opposition to what is being forecast for margins – that they will continue to trend higher. Some skepticism over whether U.S. companies will continue to grow margins in light of very low levels of profitability and lacking revenues is due. This idea needs special consideration now that the U.S. Dollar has strengthened significantly from its levels just one year ago.
The fourth risk to the stocks is a big problem in China. The Chinese economy has slowed over the last several years but rampant speculation has switched from real estate investments to stocks in mainland China. With recent regulatory changes, many retail investors have piled into Chinese stocks pushing the index to recent all-time highs.
The point is not that Chinese stocks are/are not overvalued, a good/bad investment, or in a bubble/not a bubble. The point is that there is a very significant risk that Chinese stocks will lose value very quickly even if only temporarily. Should that happen, it will have a very negative effect on U.S. stocks as investors sell their winners (U.S. stocks) to pay for their losers (Chinese stocks). In addition, risk taking would be curtailed at many financial institutions probably resulting in much tighter risk management policies. Chinese authorities are very cognizant of these issues and seem to view them through the lens of societal unrest. The People’s Bank of China and the politburo has implemented many new support structures to prevent a rapid selloff. So far these schemes have worked, but they have not prevented huge amounts of volatility. Financial systemic volatility is the real risk from Chinese stocks.
The fifth risk to the stock market is an unexpected default by Puerto Rico on their municipal debt. Last week, Governor Padilla, stated that Puerto Rico cannot pay its debts. Up and until last week, the idea that the general obligation bonds of Puerto Rico would be supported was the most commonly supported investment theme relating to Puerto Rico. That may all be changing and it’s another thing that may add to a risk off environment for stocks.
In crude terms, many retail investors have much more exposure to Puerto Rican bonds than they probably bargained for or know about. Because the bonds of Puerto Rico are “triple tax free” – no state, Federal or local income taxes – they have been very popular investments for municipal bond fund managers who desperately need higher yielding bonds in an environment of extremely low interest rates. Most people don’t consider their municipal investments as high risk capital. That is, investments in municipal bond funds tend to be made for capital preservation and income reasons. If retail investors start to see significant losses in their “safe” bond funds, hitting the sell button across portfolios is not hard to envision. In addition, there are many hedge funds that have loaded up on Puerto Rican debt. Should these funds become forced sellers there is a high likelihood stocks will also see random selling pressures.
The sixth risk to stocks is a Greek default or a Greek exit from the Euro or European Union. The current situation in Greece is very fluid with multiple and competing political, economic and structural agendas. So far the market seems to believe that the price of a Greek exit from the Euro is calculable and affordable. Investors have been reassured that although a Greek default or exit will be painful, it doesn’t present a systemic risk like bank failings à la Lehman Brothers.
The Greeks have voted “no” on the existing bailout proposals by the Troika of the European Central Bank, European Union and the International Monetary fund and have declined to pay the interest due on IMF loans. The market’s reaction so far has been slightly blasé, although probably correct. Stocks have lost several percentage points of value but real and painful volatility has not pervaded markets. The genuine impact of a Greek default or exit may still be felt as the Greeks are liable for over €3.4 billion in payments to the ECB on July 20th. With the ECB the only institution keeping the Greeks out of a humanitarian crisis via emergency lending, ignoring a Greek default or exit is folly. Where does this leave U.S. equity market participants? It leaves them in a market that is at least “fairly valued” by traditional P/E metrics, paranoid that Fed policy has been the sole driver of gains, and waiting for U.S. economic growth to catch up to stock valuations. It is a scenario very similar to last year. The real differentiator may be the strength of the U.S. Dollar and declining corporate earnings and sales. Still, all six of the enumerated risks could easily be overcome by a “low-flation” plus growth scenario in the U.S. The combination of higher capital expenditures by corporations, more efficient regulation and fiscal policy may all support domestic growth companies making outsized risks seem improbable in the near term. Knowing and understanding obvious risks never hurts though.
of the money you make goes up. So if you want the best financial portfolio like we know you do especially during these tough economic times invest in precious metals (Which are a much safer approach) and not in the stock markets! The Stock Market companies are on the fast track of going out of business because more and more people every day are turning their backs on them because of the reasons I gave earlier. Stop and think about it there is an old saying that goes like this (The more there is of something the less valuable it is) and if you think about it that is 100% true. Well there are more stocks to invest in than there are precious metals which makes the stock
Stock market risk increases over time This point reminded me of an outstanding paper by John Norstad that goes into great depth on this exact topic. The traditional measure of investment risk is called standard deviation, which essentially measures how much the return on an investment should vary from period to period. As you increase the length of time you stay invested, standard deviation decreases. By this measure, it appears that stock market risk decreases over time, and that is in fact the popular opinion expressed in almost every article on the topic. It is often the main point used when encourage young people to put most if not all of their investment money into the stock market. Norstad refutes this notion that investment risk decreases over time. His point is really quite simple, though he goes into a lot of depth proving it. While he acknowledges that the standard deviation of returns does decrease with time, he shows that that fact is largely irrelevant. What people need to be concerned with is not their return, but the amount of money they actually end up with. When viewed from this angle, it becomes quite clear that the range of possible outcomes, including the bad outcomes, increases dramatically as the length of time you invest increases. Check out the chart below taken directly from his paper: norstad risk and return What this is showing is that the longer you stay invested, the bigger your possible spread of outcomes. Investing for 40 years gives you a better chance of the great outcomes (living it up in the French Riviera, woo hoo!), but it also gives you a much better chance of the really bad outcomes. At it’s core, it’s simply saying that the longer you invest, the less certain you can be about the outcome, both for better and for worse. It’s the potential “worse” that people need to understand from a risk standpoint. Let’s look at an example This paper from Vanguard has a good discussion on how investors should think about their investment time horizon, but I want to focus on one piece of the paper that serves as a good example of what I’m talking about. On the fifth page, it provides some risk-return data using actual stock market returns from 1926-2006. On one hand, it illustrates perfectly the conventional wisdom that time decreases risk. Over 1-year periods, the stock market’s average return was 10.45%, but it’s standard deviation was 20.20%. This huge amount of variation is exactly why people warn against investing in stocks for the short term. When looking at 30-year periods, however, the picture changes dramatically. All of a sudden the average return is 11.30% and the standard deviation is only 1.38%. When viewed only through the lens of those numbers, it does indeed look like all you need is time to eliminate almost all of the risk involved with investing in the stock market. But let’s take a second to really look at what those numbers mean. Let’s say that you’ve decided that in retirement you will need $40,000 of income each year. Let’s also assume that you have 30 years to save for retirement and look at a couple of the possibilities, using the numbers from the Vanguard paper: investment risk The first row shows you the results if you save $4,262 per year and get the average 11.3% return. You’ll end up with almost exactly $1,000,000, which according to the standard 4% safe withdrawal rate will provide $40,000 per year in income. You have a 50% chance of achieving this result or better. The second row looks at the results if you fall just one standard deviation from the average. Your return is still 9.92%, which sounds great, but if you’re saving that same $4,262 per year you will only end up with enough savings to provide about $30,000 of income in retirement. That’s a 25% shortfall! And this result (or something worse) isn’t all that unlikely, occurring about 1 every 6 times. This example clearly shows that it’s not just the risk of loss that you need to be worried about. It’s the very real risk of shortfall that matters as well. That risk of shortfall is actually increased with time and increased as you invest in riskier assets (i.e. stocks). What does this mean for deciding on an investment strategy? So does all of this mean that you should avoid the stock market? Of course not. All investments come with risk and all this is showing is that stocks are no different. One of the stock market’s biggest strengths is that over the long-term the expected returns are largely worth the risk. But it’s important to remember that nothing is guaranteed and to take steps that reduce some of the risk involved, according to your personal risk tolerance. One way I’ve chosen to decrease some of this risk myself is by putting 30% of my investments into US government-issued Treasury bonds. These are some of the safest investments out there, and the primary purpose of this part of my portfolio is not to provide returns, but to provide protection during periods where stocks are not performing well. While most of my money is in the stock market, and will hopefully deliver the high long-term returns that only the stock market can deliver, at least some of my money will be shielded from significant market downturns. It’s also important to consider what kind of risk you want to take on. Investing more in stocks may give you a higher probability of reaching your retirement goal sooner or by saving less, but it also exposes you to greater risk of falling far short of your goal. A more conservative approach with more money in bonds might require you to save more or save for longer, but it will give you more certainty about reaching your goal. Another consideration is using a conservative return estimate when determining how much you need to save for retirement, or whatever other goal you’re shooting for. Like adding more bonds to your portfolio, this would result in you either having to save more or save for longer, but it leaves you with more certainty about the outcome. Conclusions There are no right or wrong answers here about how to handle the risk involved with investing. The best you can do is understand the risks involved and use that information to make decisions that fit your goals.
Stock market risk increases over time This point reminded me of an outstanding paper by John Norstad that goes into great depth on this exact topic. The traditional measure of investment risk is called standard deviation, which essentially measures how much the return on an investment should vary from period to period. As you increase the length of time you stay invested, standard deviation decreases. By this measure, it appears that stock market risk decreases over time, and that is in fact the popular opinion expressed in almost every article on the topic. It is often the main point used when encourage young people to put most if not all of their investment money into the stock market. Norstad refutes this notion that investment risk decreases over time. His point is really quite simple, though he goes into a lot of depth proving it. While he acknowledges that the standard deviation of returns does decrease with time, he shows that that fact is largely irrelevant. What people need to be concerned with is not their return, but the amount of money they actually end up with. When viewed from this angle, it becomes quite clear that the range of possible outcomes, including the bad outcomes, increases dramatically as the length of time you invest increases. Check out the chart below taken directly from his paper: norstad risk and return What this is showing is that the longer you stay invested, the bigger your possible spread of outcomes. Investing for 40 years gives you a better chance of the great outcomes (living it up in the French Riviera, woo hoo!), but it also gives you a much better chance of the really bad outcomes. At it’s core, it’s simply saying that the longer you invest, the less certain you can be about the outcome, both for better and for worse. It’s the potential “worse” that people need to understand from a risk standpoint. Let’s look at an example This paper from Vanguard has a good discussion on how investors should think about their investment time horizon, but I want to focus on one piece of the paper that serves as a good example of what I’m talking about. On the fifth page, it provides some risk-return data using actual stock market returns from 1926-2006. On one hand, it illustrates perfectly the conventional wisdom that time decreases risk. Over 1-year periods, the stock market’s average return was 10.45%, but it’s standard deviation was 20.20%. This huge amount of variation is exactly why people warn against investing in stocks for the short term. When looking at 30-year periods, however, the picture changes dramatically. All of a sudden the average return is 11.30% and the standard deviation is only 1.38%. When viewed only through the lens of those numbers, it does indeed look like all you need is time to eliminate almost all of the risk involved with investing in the stock market. But let’s take a second to really look at what those numbers mean. Let’s say that you’ve decided that in retirement you will need $40,000 of income each year. Let’s also assume that you have 30 years to save for retirement and look at a couple of the possibilities, using the numbers from the Vanguard paper: investment risk The first row shows you the results if you save $4,262 per year and get the average 11.3% return. You’ll end up with almost exactly $1,000,000, which according to the standard 4% safe withdrawal rate will provide $40,000 per year in income. You have a 50% chance of achieving this result or better. The second row looks at the results if you fall just one standard deviation from the average. Your return is still 9.92%, which sounds great, but if you’re saving that same $4,262 per year you will only end up with enough savings to provide about $30,000 of income in retirement. That’s a 25% shortfall! And this result (or something worse) isn’t all that unlikely, occurring about 1 every 6 times. This example clearly shows that it’s not just the risk of loss that you need to be worried about. It’s the very real risk of shortfall that matters as well. That risk of shortfall is actually increased with time and increased as you invest in riskier assets (i.e. stocks). What does this mean for deciding on an investment strategy? So does all of this mean that you should avoid the stock market? Of course not. All investments come with risk and all this is showing is that stocks are no different. One of the stock market’s biggest strengths is that over the long-term the expected returns are largely worth the risk. But it’s important to remember that nothing is guaranteed and to take steps that reduce some of the risk involved, according to your personal risk tolerance. One way I’ve chosen to decrease some of this risk myself is by putting 30% of my investments into US government-issued Treasury bonds. These are some of the safest investments out there, and the primary purpose of this part of my portfolio is not to provide returns, but to provide protection during periods where stocks are not performing well. While most of my money is in the stock market, and will hopefully deliver the high long-term returns that only the stock market can deliver, at least some of my money will be shielded from significant market downturns. It’s also important to consider what kind of risk you want to take on. Investing more in stocks may give you a higher probability of reaching your retirement goal sooner or by saving less, but it also exposes you to greater risk of falling far short of your goal. A more conservative approach with more money in bonds might require you to save more or save for longer, but it will give you more certainty about reaching your goal. Another consideration is using a conservative return estimate when determining how much you need to save for retirement, or whatever other goal you’re shooting for. Like adding more bonds to your portfolio, this would result in you either having to save more or save for longer, but it leaves you with more certainty about the outcome. Conclusions There are no right or wrong answers here about how to handle the risk involved with investing. The best you can do is understand the risks involved and use that information to make decisions that fit your goals.
markets a much riskier investment than precious metals. So if you want the best financial portfolio like I know you do especially in these tough economic times invest in precious metals and not in the stock markets. If you want to know where to go to find out how to invest in precious metals go to these 3 websites www.monex.com, www.jsmineset.com, www.themorganreport.com . By investing in precious metals you will be having a precious golden portfolio that you can be proud of for a lifetime. I want to thank you for reading the info on this website and I want to wish you financial health. One last word of advice please check with a financial advisor before following any of our advice! This is Robert Custer, Founder/President and CEO.
Risks of stocks Page Content When you invest in a stock, you could lose all of your money – in some cases, more than you invested. Before you buy a stock, understand the risks and decide if they are risks you are comfortable taking. Main Content Body 2 key investment risks 1.Returns are not guaranteed – While stocks have historically performed well over the long term, there's no guarantee you'll make money on a stock at any given point in time. Although a number of things can help you assess a stock, no one can predict exactly how a stock will perform in the future. There's no guarantee prices will go up or that the company will pay dividends. Or that a company will even stay in business. 2.You may lose money – Stock prices can change often and for many reasons. You have to be comfortable with the risk that you might lose all of your money when you buy and sell stocks, especially if you're not planning to invest for the long term. If you use leverage to invest in stocks, like buying on margin or short selling, you could lose more than you invest. A word about volatility There are always ups and downs in the stock market. A stock price that changes quickly and by a lot is more "volatile”. This makes a stock riskier – you could lose a lot if you had to get your money out on short notice. It’s not enough to just look at a stock’s volatility from day to day. You should also look at the largest monthly or quarterly loss recorded. Volatility is measured in very precise ways: •standard deviation – measures how widely a stock’s price has gone up and down in the past from its average price. More change results in a higher historic volatility. •beta – measures how the stock is doing compared to a given benchmark, such as the S&P TSX Composite Index. A beta of 1.0 tells you that a stock has been going up and down with the overall stock market. A stock with a beta between 0.0 and 1.0 has smaller ups and downs. A beta greater than 1.0 has wider price swings. Stocks with a negative beta are moving opposite to the index. 6 ways to manage risk 1. Hold a diversified stock portfolio You may be able to reduce the ups and downs in the total value of your stock portfolio by buying stocks from companies with different features: •Type of industry – While companies in one industry may struggle, companies in another industry may be doing well. For example, energy stocks might slump while technology stocks are rising. •Company size – Investing in a smaller, newer company can offer the potential for higher growth, but it’s usually riskier than a larger, more stable company with a long history and good track record. You can reduce your overall risk by owning stock in companies of different sizes. •Type of stock – Preferred shares tend to offer lower risk and returns than common shares. But they pay a fixed dividend, unlike common shares. You may want to choose both for your portfolio. Learn more about common and preferred stock. Before you decide on a stock or a portfolio of stocks, figure out how it fits with the rest of the investments you own, your overall financial goals and your tolerance for risk. Learn more about the risks of investing and how diversification can help reduce your overall risk. 2. Invest for the long term The stock market is subject to short-term fluctuations, as well as bear markets. But over the long term, the stock market has historically performed well. If you buy stock with money that you may need soon, you may be forced to sell in a period when a stock’s price is down. If you buy high and sell low, you'll lose money. 3. Don’t try to time the market Trying to time the market can be a risky strategy. You may hear about a stock that is climbing higher and higher in price. When more investors decide to jump in and buy the stock, they drive prices up even more. The price can fall just as fast, though, as investors start to sell to cash in on the big gains. Other investors make the mistake of selling as soon as a stock price falls. But you don’t lose money on a stock until you sell it. If you hold on, the price may come back up. Stocks are long-term investments with many short-term fluctuations in price. 4. Get advice if you’re not a knowledgeable investor It’s always risky to invest when you don’t understand how the stock market works, what makes a stock’s price rise or fall, or how an investment or investment strategy works. The more you know, the more you can lower this risk. If you don't feel comfortable with your level of knowledge, a qualified advisor can help you choose stocks and other investments that meet your goals and tolerance for risk. 5. Be careful about buying private stock Some companies keep their stock in private hands instead of trading their stock publicly on the stock market. The stock is owned by a group of shareholders who can only sell their stock with approval from other shareholders. The shareholders set the price at which the stock can change hands. Buying private stock is risky because: •You may not be able to buy or sell the stock when you want to. •You may have to make a large investment (unless you are an employee of the company). •It may even be a scam. 6. Be aware of the dangers of investing offshore Canada’s securities and banking laws protect you by offering recourse through the courts if you feel you have been harmed in your investing. When your money goes to another country, you may lose that protection. If you’re approached about investing offshore, be cautious – it could be a scam. Robert Custer <robertcuster38@gmail.com> Apr 29 to scuster The Reality of Investment Risk When it comes to risk, here’s a reality check: All investments carry some degree of risk. Stocks, bonds, mutual funds and exchange-traded funds can lose value, even all their value, if market conditions sour. Even conservative, insured investments, such as certificates of deposit (CDs) issued by a bank or credit union, come with inflation risk. They may not earn enough over time to keep pace with the increasing cost of living. What Is Risk? When you invest, you make choices about what to do with your financial assets. Risk is any uncertainty with respect to your investments that has the potential to negatively affect your financial welfare. For example, your investment value might rise or fall because of market conditions (market risk). Corporate decisions, such as whether to expand into a new area of business or merge with another company, can affect the value of your investments (business risk). If you own an international investment, events within that country can affect your investment (political risk and currency risk, to name two). There are other types of risk. How easy or hard it is to cash out of an investment when you need to is called liquidity risk. Another risk factor is tied to how many or how few investments you hold. Generally speaking, the more financial eggs you have in one basket, say all your money in a single stock, the greater risk you take (concentration risk). In short, risk is the possibility that a negative financial outcome that matters to you might occur. There are several key concepts you should understand when it comes to investment risk. Risk and Reward. The level of risk associated with a particular investment or asset class typically correlates with the level of return the investment might achieve. The rationale behind this relationship is that investors willing to take on risky investments and potentially lose money should be rewarded for their risk. In the context of investing, reward is the possibility of higher returns. Historically, stocks have enjoyed the most robust average annual returns over the long term (just over 10 percent per year), followed by corporate bonds (around 6 percent annually), Treasury bonds (5.5 percent per year) and cash/cash equivalents such as short-term Treasury bills (3.5 percent per year). The tradeoff is that with this higher return comes greater risk: as an asset class, stocks are riskier than corporate bonds, and corporate bonds are riskier than Treasury bonds or bank savings products. Exceptions Abound Although stocks have historically provided a higher return than bonds and cash investments (albeit, at a higher level of risk), it is not always the case that stocks outperform bonds or that bonds are lower risk than stocks. Both stocks and bonds involve risk, and their returns and risk levels can vary depending on the prevailing market and economic conditions and the manner in which they are used. So, even though target-date funds are generally designed to become more conservative as the target date approaches, investment risk exists throughout the lifespan of the fund. Averages and Volatility. While historic averages over long periods can guide decision-making about risk, it can be difficult to predict (and impossible to know) whether, given your specific circumstances and with your particular goals and needs, the historical averages will play in your favor. Even if you hold a broad, diversified portfolio of stocks such as the S&P 500 for an extended period of time, there is no guarantee that they will earn a rate of return equal to the long-term historical average. The timing of both the purchase and sale of an investment are key determinants of your investment return (along with fees). But while we have all heard the adage, “buy low and sell high,” the reality is that many investors do just the opposite. If you buy a stock or stock mutual fund when the market is hot and prices are high, you will have greater losses if the price drops for any reason compared with an investor who bought at a lower price. That means your average annualized returns will be less than theirs, and it will take you longer to recover. Investors should also understand that holding a portfolio of stocks even for an extended period of time can result in negative returns. For example, on March 10, 2000, the NASDAQ composite closed at all-time high of 5,048.62. It has only been recently that the closing price has approached this record level, and for well over a decade the NASDAQ Composite was well off its historic high. In short, if you bought at or near the market’s peak, you may still not be seeing a positive return on your investment. Investors holding individual stocks for an extended period of time also face the risk that the company they are invested in could enter a state of permanent decline or go bankrupt. Time Can Be Your Friend or Foe Based on historical data, holding a broad portfolio of stocks over an extended period of time (for instance a large-cap portfolio like the S&P 500 over a 20-year period) significantly reduces your chances of losing your principal. However, the historical data should not mislead investors into thinking that there is no risk in investing in stocks over a long period of time. For example, suppose an investor invests $10,000 in a broadly diversified stock portfolio and 19 years later sees that portfolio grow to $20,000. The following year, the investor’s portfolio loses 20 percent of its value, or $4,000, during a market downturn. As a result, at the end of the 20-year period, the investor ends up with a $16,000 portfolio, rather than the $20,000 portfolio she held after 19 years. Money was made—but not as much as if shares were sold the previous year. That’s why stocks are always risky investments, even over the long-term. They don’t get safer the longer you hold them. This is not a hypothetical risk. If you had planned to retire in the 2008 to 2009 timeframe—when stock prices dropped by 57 percent—and had the bulk of your retirement savings in stocks or stock mutual funds, you might have had to reconsider your retirement plan. Investors should also consider how realistic it will be for them to ride out the ups and downs of the market over the long-term. Will you have to sell stocks during an economic downturn to fill the gap caused by a job loss? Will you sell investments to pay for medical care or a child’s college education? Predictable and unpredictable life events might make it difficult for some investors to stay invested in stocks over an extended period of time. Managing Risk You cannot eliminate investment risk. But two basic investment strategies can help manage both systemic risk (risk affecting the economy as a whole) and non-systemic risk (risks that affect a small part of the economy, or even a single company). Asset Allocation. By including different asset classes in your portfolio (for example stocks, bonds, real estate and cash), you increase the probability that some of your investments will provide satisfactory returns even if others are flat or losing value. Put another way, you're reducing the risk of major losses that can result from over-emphasizing a single asset class, however resilient you might expect that class to be. Diversification. When you diversify, you divide the money you've allocated to a particular asset class, such as stocks, among various categories of investments that belong to that asset class. Diversification, with its emphasis on variety, allows you to spread you assets around. In short, you don’t put all your investment eggs in one basket. Hedging (buying a security to offset a potential loss on another investment) and insurance can provide additional ways to manage risk. However, both strategies typically add (often significantly) to the costs of your investment, which eats away any returns. In addition, hedging typically involves speculative, higher risk activity such as short selling (buying or selling securities you do not own) or investing in illiquid securities. The bottom line is all investments carry some degree of risk. By better understanding the nature of risk, and taking steps to manage those risks, you put yourself in a better position to meet your financial goals. - See more at: http://www.finra.org/investors/reality-investment-risk#sthash.3woXwx7n.dpuf Stock market risk increases over time This point reminded me of an outstanding paper by John Norstad that goes into great depth on this exact topic. The traditional measure of investment risk is called standard deviation, which essentially measures how much the return on an investment should vary from period to period. As you increase the length of time you stay invested, standard deviation decreases. By this measure, it appears that stock market risk decreases over time, and that is in fact the popular opinion expressed in almost every article on the topic. It is often the main point used when encourage young people to put most if not all of their investment money into the stock market. Norstad refutes this notion that investment risk decreases over time. His point is really quite simple, though he goes into a lot of depth proving it. While he acknowledges that the standard deviation of returns does decrease with time, he shows that that fact is largely irrelevant. What people need to be concerned with is not their return, but the amount of money they actually end up with. When viewed from this angle, it becomes quite clear that the range of possible outcomes, including the bad outcomes, increases dramatically as the length of time you invest increases. Check out the chart below taken directly from his paper: norstad risk and return What this is showing is that the longer you stay invested, the bigger your possible spread of outcomes. Investing for 40 years gives you a better chance of the great outcomes (living it up in the French Riviera, woo hoo!), but it also gives you a much better chance of the really bad outcomes. At it’s core, it’s simply saying that the longer you invest, the less certain you can be about the outcome, both for better and for worse. It’s the potential “worse” that people need to understand from a risk standpoint. Let’s look at an example This paper from Vanguard has a good discussion on how investors should think about their investment time horizon, but I want to focus on one piece of the paper that serves as a good example of what I’m talking about. On the fifth page, it provides some risk-return data using actual stock market returns from 1926-2006. On one hand, it illustrates perfectly the conventional wisdom that time decreases risk. Over 1-year periods, the stock market’s average return was 10.45%, but it’s standard deviation was 20.20%. This huge amount of variation is exactly why people warn against investing in stocks for the short term. When looking at 30-year periods, however, the picture changes dramatically. All of a sudden the average return is 11.30% and the standard deviation is only 1.38%. When viewed only through the lens of those numbers, it does indeed look like all you need is time to eliminate almost all of the risk involved with investing in the stock market. But let’s take a second to really look at what those numbers mean. Let’s say that you’ve decided that in retirement you will need $40,000 of income each year. Let’s also assume that you have 30 years to save for retirement and look at a couple of the possibilities, using the numbers from the Vanguard paper: investment risk The first row shows you the results if you save $4,262 per year and get the average 11.3% return. You’ll end up with almost exactly $1,000,000, which according to the standard 4% safe withdrawal rate will provide $40,000 per year in income. You have a 50% chance of achieving this result or better. The second row looks at the results if you fall just one standard deviation from the average. Your return is still 9.92%, which sounds great, but if you’re saving that same $4,262 per year you will only end up with enough savings to provide about $30,000 of income in retirement. That’s a 25% shortfall! And this result (or something worse) isn’t all that unlikely, occurring about 1 every 6 times. This example clearly shows that it’s not just the risk of loss that you need to be worried about. It’s the very real risk of shortfall that matters as well. That risk of shortfall is actually increased with time and increased as you invest in riskier assets (i.e. stocks). What does this mean for deciding on an investment strategy? So does all of this mean that you should avoid the stock market? Of course not. All investments come with risk and all this is showing is that stocks are no different. One of the stock market’s biggest strengths is that over the long-term the expected returns are largely worth the risk. But it’s important to remember that nothing is guaranteed and to take steps that reduce some of the risk involved, according to your personal risk tolerance. One way I’ve chosen to decrease some of this risk myself is by putting 30% of my investments into US government-issued Treasury bonds. These are some of the safest investments out there, and the primary purpose of this part of my portfolio is not to provide returns, but to provide protection during periods where stocks are not performing well. While most of my money is in the stock market, and will hopefully deliver the high long-term returns that only the stock market can deliver, at least some of my money will be shielded from significant market downturns. It’s also important to consider what kind of risk you want to take on. Investing more in stocks may give you a higher probability of reaching your retirement goal sooner or by saving less, but it also exposes you to greater risk of falling far short of your goal. A more conservative approach with more money in bonds might require you to save more or save for longer, but it will give you more certainty about reaching your goal. Another consideration is using a conservative return estimate when determining how much you need to save for retirement, or whatever other goal you’re shooting for. Like adding more bonds to your portfolio, this would result in you either having to save more or save for longer, but it leaves you with more certainty about the outcome. Conclusions There are no right or wrong answers here about how to handle the risk involved with investing. The best you can do is understand the risks involved and use that information to make decisions that fit your goals.
Risks of stocks Page Content When you invest in a stock, you could lose all of your money – in some cases, more than you invested. Before you buy a stock, understand the risks and decide if they are risks you are comfortable taking. Main Content Body 2 key investment risks 1.Returns are not guaranteed – While stocks have historically performed well over the long term, there's no guarantee you'll make money on a stock at any given point in time. Although a number of things can help you assess a stock, no one can predict exactly how a stock will perform in the future. There's no guarantee prices will go up or that the company will pay dividends. Or that a company will even stay in business. 2.You may lose money – Stock prices can change often and for many reasons. You have to be comfortable with the risk that you might lose all of your money when you buy and sell stocks, especially if you're not planning to invest for the long term. If you use leverage to invest in stocks, like buying on margin or short selling, you could lose more than you invest. A word about volatility There are always ups and downs in the stock market. A stock price that changes quickly and by a lot is more "volatile”. This makes a stock riskier – you could lose a lot if you had to get your money out on short notice. It’s not enough to just look at a stock’s volatility from day to day. You should also look at the largest monthly or quarterly loss recorded. Volatility is measured in very precise ways: •standard deviation – measures how widely a stock’s price has gone up and down in the past from its average price. More change results in a higher historic volatility. •beta – measures how the stock is doing compared to a given benchmark, such as the S&P TSX Composite Index. A beta of 1.0 tells you that a stock has been going up and down with the overall stock market. A stock with a beta between 0.0 and 1.0 has smaller ups and downs. A beta greater than 1.0 has wider price swings. Stocks with a negative beta are moving opposite to the index. 6 ways to manage risk 1. Hold a diversified stock portfolio You may be able to reduce the ups and downs in the total value of your stock portfolio by buying stocks from companies with different features: •Type of industry – While companies in one industry may struggle, companies in another industry may be doing well. For example, energy stocks might slump while technology stocks are rising. •Company size – Investing in a smaller, newer company can offer the potential for higher growth, but it’s usually riskier than a larger, more stable company with a long history and good track record. You can reduce your overall risk by owning stock in companies of different sizes. •Type of stock – Preferred shares tend to offer lower risk and returns than common shares. But they pay a fixed dividend, unlike common shares. You may want to choose both for your portfolio. Learn more about common and preferred stock. Before you decide on a stock or a portfolio of stocks, figure out how it fits with the rest of the investments you own, your overall financial goals and your tolerance for risk. Learn more about the risks of investing and how diversification can help reduce your overall risk. 2. Invest for the long term The stock market is subject to short-term fluctuations, as well as bear markets. But over the long term, the stock market has historically performed well. If you buy stock with money that you may need soon, you may be forced to sell in a period when a stock’s price is down. If you buy high and sell low, you'll lose money. 3. Don’t try to time the market Trying to time the market can be a risky strategy. You may hear about a stock that is climbing higher and higher in price. When more investors decide to jump in and buy the stock, they drive prices up even more. The price can fall just as fast, though, as investors start to sell to cash in on the big gains. Other investors make the mistake of selling as soon as a stock price falls. But you don’t lose money on a stock until you sell it. If you hold on, the price may come back up. Stocks are long-term investments with many short-term fluctuations in price. 4. Get advice if you’re not a knowledgeable investor It’s always risky to invest when you don’t understand how the stock market works, what makes a stock’s price rise or fall, or how an investment or investment strategy works. The more you know, the more you can lower this risk. If you don't feel comfortable with your level of knowledge, a qualified advisor can help you choose stocks and other investments that meet your goals and tolerance for risk. 5. Be careful about buying private stock Some companies keep their stock in private hands instead of trading their stock publicly on the stock market. The stock is owned by a group of shareholders who can only sell their stock with approval from other shareholders. The shareholders set the price at which the stock can change hands. Buying private stock is risky because: •You may not be able to buy or sell the stock when you want to. •You may have to make a large investment (unless you are an employee of the company). •It may even be a scam. 6. Be aware of the dangers of investing offshore Canada’s securities and banking laws protect you by offering recourse through the courts if you feel you have been harmed in your investing. When your money goes to another country, you may lose that protection. If you’re approached about investing offshore, be cautious – it could be a scam. Robert Custer <robertcuster38@gmail.com> Apr 29 to scuster The Reality of Investment Risk When it comes to risk, here’s a reality check: All investments carry some degree of risk. Stocks, bonds, mutual funds and exchange-traded funds can lose value, even all their value, if market conditions sour. Even conservative, insured investments, such as certificates of deposit (CDs) issued by a bank or credit union, come with inflation risk. They may not earn enough over time to keep pace with the increasing cost of living. What Is Risk? When you invest, you make choices about what to do with your financial assets. Risk is any uncertainty with respect to your investments that has the potential to negatively affect your financial welfare. For example, your investment value might rise or fall because of market conditions (market risk). Corporate decisions, such as whether to expand into a new area of business or merge with another company, can affect the value of your investments (business risk). If you own an international investment, events within that country can affect your investment (political risk and currency risk, to name two). There are other types of risk. How easy or hard it is to cash out of an investment when you need to is called liquidity risk. Another risk factor is tied to how many or how few investments you hold. Generally speaking, the more financial eggs you have in one basket, say all your money in a single stock, the greater risk you take (concentration risk). In short, risk is the possibility that a negative financial outcome that matters to you might occur. There are several key concepts you should understand when it comes to investment risk. Risk and Reward. The level of risk associated with a particular investment or asset class typically correlates with the level of return the investment might achieve. The rationale behind this relationship is that investors willing to take on risky investments and potentially lose money should be rewarded for their risk. In the context of investing, reward is the possibility of higher returns. Historically, stocks have enjoyed the most robust average annual returns over the long term (just over 10 percent per year), followed by corporate bonds (around 6 percent annually), Treasury bonds (5.5 percent per year) and cash/cash equivalents such as short-term Treasury bills (3.5 percent per year). The tradeoff is that with this higher return comes greater risk: as an asset class, stocks are riskier than corporate bonds, and corporate bonds are riskier than Treasury bonds or bank savings products. Exceptions Abound Although stocks have historically provided a higher return than bonds and cash investments (albeit, at a higher level of risk), it is not always the case that stocks outperform bonds or that bonds are lower risk than stocks. Both stocks and bonds involve risk, and their returns and risk levels can vary depending on the prevailing market and economic conditions and the manner in which they are used. So, even though target-date funds are generally designed to become more conservative as the target date approaches, investment risk exists throughout the lifespan of the fund. Averages and Volatility. While historic averages over long periods can guide decision-making about risk, it can be difficult to predict (and impossible to know) whether, given your specific circumstances and with your particular goals and needs, the historical averages will play in your favor. Even if you hold a broad, diversified portfolio of stocks such as the S&P 500 for an extended period of time, there is no guarantee that they will earn a rate of return equal to the long-term historical average. The timing of both the purchase and sale of an investment are key determinants of your investment return (along with fees). But while we have all heard the adage, “buy low and sell high,” the reality is that many investors do just the opposite. If you buy a stock or stock mutual fund when the market is hot and prices are high, you will have greater losses if the price drops for any reason compared with an investor who bought at a lower price. That means your average annualized returns will be less than theirs, and it will take you longer to recover. Investors should also understand that holding a portfolio of stocks even for an extended period of time can result in negative returns. For example, on March 10, 2000, the NASDAQ composite closed at all-time high of 5,048.62. It has only been recently that the closing price has approached this record level, and for well over a decade the NASDAQ Composite was well off its historic high. In short, if you bought at or near the market’s peak, you may still not be seeing a positive return on your investment. Investors holding individual stocks for an extended period of time also face the risk that the company they are invested in could enter a state of permanent decline or go bankrupt. Time Can Be Your Friend or Foe Based on historical data, holding a broad portfolio of stocks over an extended period of time (for instance a large-cap portfolio like the S&P 500 over a 20-year period) significantly reduces your chances of losing your principal. However, the historical data should not mislead investors into thinking that there is no risk in investing in stocks over a long period of time. For example, suppose an investor invests $10,000 in a broadly diversified stock portfolio and 19 years later sees that portfolio grow to $20,000. The following year, the investor’s portfolio loses 20 percent of its value, or $4,000, during a market downturn. As a result, at the end of the 20-year period, the investor ends up with a $16,000 portfolio, rather than the $20,000 portfolio she held after 19 years. Money was made—but not as much as if shares were sold the previous year. That’s why stocks are always risky investments, even over the long-term. They don’t get safer the longer you hold them. This is not a hypothetical risk. If you had planned to retire in the 2008 to 2009 timeframe—when stock prices dropped by 57 percent—and had the bulk of your retirement savings in stocks or stock mutual funds, you might have had to reconsider your retirement plan. Investors should also consider how realistic it will be for them to ride out the ups and downs of the market over the long-term. Will you have to sell stocks during an economic downturn to fill the gap caused by a job loss? Will you sell investments to pay for medical care or a child’s college education? Predictable and unpredictable life events might make it difficult for some investors to stay invested in stocks over an extended period of time. Managing Risk You cannot eliminate investment risk. But two basic investment strategies can help manage both systemic risk (risk affecting the economy as a whole) and non-systemic risk (risks that affect a small part of the economy, or even a single company). Asset Allocation. By including different asset classes in your portfolio (for example stocks, bonds, real estate and cash), you increase the probability that some of your investments will provide satisfactory returns even if others are flat or losing value. Put another way, you're reducing the risk of major losses that can result from over-emphasizing a single asset class, however resilient you might expect that class to be. Diversification. When you diversify, you divide the money you've allocated to a particular asset class, such as stocks, among various categories of investments that belong to that asset class. Diversification, with its emphasis on variety, allows you to spread you assets around. In short, you don’t put all your investment eggs in one basket. Hedging (buying a security to offset a potential loss on another investment) and insurance can provide additional ways to manage risk. However, both strategies typically add (often significantly) to the costs of your investment, which eats away any returns. In addition, hedging typically involves speculative, higher risk activity such as short selling (buying or selling securities you do not own) or investing in illiquid securities. The bottom line is all investments carry some degree of risk. By better understanding the nature of risk, and taking steps to manage those risks, you put yourself in a better position to meet your financial goals. - See more at: http://www.finra.org/investors/reality-investment-risk#sthash.3woXwx7n.dpuf Stock market risk increases over time This point reminded me of an outstanding paper by John Norstad that goes into great depth on this exact topic. The traditional measure of investment risk is called standard deviation, which essentially measures how much the return on an investment should vary from period to period. As you increase the length of time you stay invested, standard deviation decreases. By this measure, it appears that stock market risk decreases over time, and that is in fact the popular opinion expressed in almost every article on the topic. It is often the main point used when encourage young people to put most if not all of their investment money into the stock market. Norstad refutes this notion that investment risk decreases over time. His point is really quite simple, though he goes into a lot of depth proving it. While he acknowledges that the standard deviation of returns does decrease with time, he shows that that fact is largely irrelevant. What people need to be concerned with is not their return, but the amount of money they actually end up with. When viewed from this angle, it becomes quite clear that the range of possible outcomes, including the bad outcomes, increases dramatically as the length of time you invest increases. Check out the chart below taken directly from his paper: norstad risk and return What this is showing is that the longer you stay invested, the bigger your possible spread of outcomes. Investing for 40 years gives you a better chance of the great outcomes (living it up in the French Riviera, woo hoo!), but it also gives you a much better chance of the really bad outcomes. At it’s core, it’s simply saying that the longer you invest, the less certain you can be about the outcome, both for better and for worse. It’s the potential “worse” that people need to understand from a risk standpoint. Let’s look at an example This paper from Vanguard has a good discussion on how investors should think about their investment time horizon, but I want to focus on one piece of the paper that serves as a good example of what I’m talking about. On the fifth page, it provides some risk-return data using actual stock market returns from 1926-2006. On one hand, it illustrates perfectly the conventional wisdom that time decreases risk. Over 1-year periods, the stock market’s average return was 10.45%, but it’s standard deviation was 20.20%. This huge amount of variation is exactly why people warn against investing in stocks for the short term. When looking at 30-year periods, however, the picture changes dramatically. All of a sudden the average return is 11.30% and the standard deviation is only 1.38%. When viewed only through the lens of those numbers, it does indeed look like all you need is time to eliminate almost all of the risk involved with investing in the stock market. But let’s take a second to really look at what those numbers mean. Let’s say that you’ve decided that in retirement you will need $40,000 of income each year. Let’s also assume that you have 30 years to save for retirement and look at a couple of the possibilities, using the numbers from the Vanguard paper: investment risk The first row shows you the results if you save $4,262 per year and get the average 11.3% return. You’ll end up with almost exactly $1,000,000, which according to the standard 4% safe withdrawal rate will provide $40,000 per year in income. You have a 50% chance of achieving this result or better. The second row looks at the results if you fall just one standard deviation from the average. Your return is still 9.92%, which sounds great, but if you’re saving that same $4,262 per year you will only end up with enough savings to provide about $30,000 of income in retirement. That’s a 25% shortfall! And this result (or something worse) isn’t all that unlikely, occurring about 1 every 6 times. This example clearly shows that it’s not just the risk of loss that you need to be worried about. It’s the very real risk of shortfall that matters as well. That risk of shortfall is actually increased with time and increased as you invest in riskier assets (i.e. stocks). What does this mean for deciding on an investment strategy? So does all of this mean that you should avoid the stock market? Of course not. All investments come with risk and all this is showing is that stocks are no different. One of the stock market’s biggest strengths is that over the long-term the expected returns are largely worth the risk. But it’s important to remember that nothing is guaranteed and to take steps that reduce some of the risk involved, according to your personal risk tolerance. One way I’ve chosen to decrease some of this risk myself is by putting 30% of my investments into US government-issued Treasury bonds. These are some of the safest investments out there, and the primary purpose of this part of my portfolio is not to provide returns, but to provide protection during periods where stocks are not performing well. While most of my money is in the stock market, and will hopefully deliver the high long-term returns that only the stock market can deliver, at least some of my money will be shielded from significant market downturns. It’s also important to consider what kind of risk you want to take on. Investing more in stocks may give you a higher probability of reaching your retirement goal sooner or by saving less, but it also exposes you to greater risk of falling far short of your goal. A more conservative approach with more money in bonds might require you to save more or save for longer, but it will give you more certainty about reaching your goal. Another consideration is using a conservative return estimate when determining how much you need to save for retirement, or whatever other goal you’re shooting for. Like adding more bonds to your portfolio, this would result in you either having to save more or save for longer, but it leaves you with more certainty about the outcome. Conclusions There are no right or wrong answers here about how to handle the risk involved with investing. The best you can do is understand the risks involved and use that information to make decisions that fit your goals.