Investing always carries some amount of risk, whether you’re investing in stocks, bonds, real estate, or a lower-risk investment like CDs or Treasury-issued securities. When you think of investment risk, you probably think of the risk of losing some or all of your money because of a bad investment decision or a market downturn. But that’s not the only risk you face as an investor. There are some apparently harmless risks as well.
What many investors don’t realize is that if you don’t invest aggressively enough, inflation will cause your money to lose value over time. If you rely on socking money away in a savings account to get you through retirement, your future purchasing power is sure to disappoint. While you can’t avoid all investment risk, you can mitigate it by learning about the different types of investment vehicles available, developing a sound investment strategy, and letting time work its magic to help your portfolio grow.
Not Investing Is Just as Risky as Investing Unwisely
Lots of people these days are uncomfortable investing in the stock market, especially young people. Millennials are far more likely than older generations to be wary of stock market volatility, with 52 percent keeping savings in cash and 28 percent putting their savings into stocks.
Among gen X and baby boomers, only 23 percent hang on to their savings in cash while 46 percent feel comfortable putting it all in stocks. Forty-three percent of millennials say they will never feel comfortable with investing in the stock market.
So if you’re worried about the risks of investing in the stock market, you’re not alone. Your concerns are perfectly understandable, especially given the recent economic downturn. But you can’t avoid all investment risk by not investing because not investing is just as risky as investing — perhaps even more so.
Why? The answer is inflation. Historically, the average rate of inflation is about three percent a year, but a savings account, money market account, CD, or another low-risk investment vehicle is only going to net you about two percent interest a year. That means your money is worth a little less every year.
The only way your money will have a chance to grow faster than inflation can erode its value is if you invest it in stocks or its derivatives, such as an index fund or mutual fund. Sure, there’s a risk that you may lose money in the short term. But if you can leave your money in the stock market for a long time — 10 years or longer — you’ll experience returns that, historically, have outpaced inflation since the 1940s.
Mitigate Your Investment Risk
Investing is risky, but it’s something you need to do if you want to save enough money for your future goals — just like driving a car is risky, but you probably need to do it if you want to get to work on time.
The younger you are, the more time you have to let your money grow before you need to use it, and the more likely you will be to recoup any investment losses. But you should also have a solid investment strategy.
Diversification is an important part of protecting your portfolio from market downturns and poor performance of any one stock. If you hold shares in many companies throughout an industry, then you’ll take less of a hit if one of those companies does poorly.
That’s why many people invest in the stock market today through mutual funds — mutual funds allow you to instantly diversify your holdings by allowing you to pool your money with that of other investors to buy shares in a range of different companies. It takes some of the pressure off.
Another way to invest wisely without assuming too much risk is to invest in index funds. Index funds consistently outperform other investments in both bear and bull markets. These funds allow you to invest in thousands of different positions across the market while keeping your operating costs — the fees you’re charged as investor — low.
If you’re leery of putting your entire nest egg into the stock market, well, you don’t have to. In fact, if you’re new to investing, it’s a good idea not to throw all your money into stocks, bonds, or other investment vehicles all at once. Take time to read up on investment strategies and clarify your goals.
At the same time, do not over-diversify your portfolio, that can lower your return on investment if diversification makes it difficult to manage all investment accounts.
Commit to adding a small amount of money to your investment accounts each week or month, so that saving for the future becomes a habitual part of your daily expenses.
Try not to scrutinize your investments’ performance too closely; while you definitely want to see growth over time, the day-to-day performance of your stocks and bonds won’t mean much compared to their value in 10, 20, or 30 years, when you need to cash them out.
There’s no such thing as a risk-free investment, but that doesn’t mean you shouldn’t invest.
Investing in the stock market is the only way you’ll be able to save money at a rate that outpaces inflation over the years. Don’t let your fear of stock market losses keep you from achieving your future financial goals.
Readers, how do you manage your investment risk, apart from diversification strategy?