Risk is not a four-letter word
Cover photo credit: www.meisterdrucke.ie
The word risk often carries a negative connotation, but risk is just a word for uncertainty.
When it comes to your money, you often want to be certain that you can buy groceries and pay your mortgage – and we keep this money in a bank account where it is secure and certain to be available when you need it.
The downside to certainty is that it doesn’t pay very well. If you want perpetual access to your money, the bank can’t lend it out for profit; thus, they are limited in what they can pay you in interest.
To achieve the modern concept of retirement – that is, to quit working and live off your savings for 20-30 years – you will most likely need your savings to earn more than the paltry bank account return. In other words, you will need to put your money at risk. No, I don’t mean sending it to a Nigerian prince; I’m talking about investing in for-profit businesses – I’m talking about the US stock market.
The ups and downs of the stock market
Historically, the US stock market has been a solid long-term investment. Between 1926 and 2024, the S&P 500 (a measuring stick for the largest US companies) has returned on average over 10% annually. However, the stock market is very volatile on a short-term basis (perhaps you’ve heard).
While the average return is around 10%, one can expect the return in any given year to be anywhere between 30% and minus 10%. In other words, your $10,000 investment could, within a year, turn into $13,000 or into $9,000 – and it very often does worse than that. Talk about uncertainty!
From this information we can derive two very important principles of investing that will make the uncertainty more tolerable:
Foundational principles of investing
First, do not invest any money in the stock market that you will need to spend within the next 5-10 years. Sure, it may stink to have your money in the bank when the stock market is tearing 20% returns, but it sure beats having to tell your daughter she can’t have cake at her wedding because dad was making risky investments.
Second, you should never sell in a panic. If you followed the first principle and only invested what you did not need to spend imminently, the best action is to maintain your investments and wait for the inevitable recovery. As a tallgrass prairie is rejuvenated by fire, so does the stock market recover from market crashes.
The bottom line
Without risk, there would be no return. Over long time periods, the US stock market has provided a moderate rate of return, but investing in stocks for a short-term return is much riskier. Your portfolio should contain less risky assets to cover emergencies and short-term spending needs.
About the Author
Joseph Fowler, CFP® is a financial planner and co-owner of 402 Financial in Lincoln, NE.
402 Financial provides financial planning and investment management services to people approaching or in retirement. Joe always acts as a fiduciary and never takes commissions on product sales.
If you are considering retirement, click this link to see if you have enough.
