What is risk in investing?
In investing, typically people think of risk as the chances you will lose money. I have heard it remarked that investing in the stock market is no different than gambling. Can you lose money investing? It is always possible. There is a reason the regulatory agencies make us put those disclaimers on all our documentation. Take a look at the chart shown above and consider these facts:
- since 1928, the S&P 500 (a good representation of the stock market as a whole) has increased in value 67% of the time.
- Since 1928, there has never been a 20 year period where the S&P 500 has lost value.
- Since 1990, the average return for the S&P 500 has been 9.2%.
So what does this tell us?
For starters, this tells us that so long as you bought and held a well diversified portfolio of stocks, the chance was essentially zero that you would lose money on your investment if you held it for at least 20 years. It also tells us that in more recent history, we have seen high average returns even with what some would categorize as catastrophic events on the 2000 dot come crash and the 2008 banking crisis.
What doesn't this tell us?
The data doesn't guarantee anything in the future. It is impossible to know how markets will react to events don't even know are going to happen. When you don't have the best data possible (what will happen) you are forced to used the best data available (what has happened).
The Other Risk (the "I" Word)
Imagination.
Just kidding, it is inflation. That pesky little bugger that continues to make our stuff worth less each and (almost) every year. Since 1990, inflation has averaged around 2.48% per year. When it comes to your savings in retirement, this means your money buys less year after year. On top of that, you are likely going to be using your retirement savings to live off of in retirement so in an optimal situation, you would actually be growing your assets. One of the best ways to do that is to invest your money. But in what?
Which Risk is Greater? Market downturns or inflation?
A common way to fight inflation is by investing into the stock market. It has historically been shown to have the been long-term returns. Nobody likes to see their retirement assets go down in value. This type of volatility is easy to see because you can easily see it by the dollar amount of your investments. Inflation is not so easy to see. There isn't a metric to show you what your investments are worth year to year after inflation is taken out.
Let's remind ourselves of two of the facts shown above
- Since 1990, the average return for the S&P 500 has been 9.2%.
- Since 1990, inflation has averaged around 2.48% per year.
When it comes to risk, the way I like to think of it is asking myself, "what is more likely to happen?" In this case, which is more likely to happen:
- a giant stock market crash where you lose a majority of the value of your investments
OR
inflation slowly eroding your purchasing power each year possibly leading to you outliving your money.
Let me see (*checks notes*), the first situation has never happened in the last 100 years whereas the second (*checks notes again*) happens almost ever year.
Emotional Warfare
When it comes to retirement, most people want a sure thing. They want growth without any chance of losing money. The reality is there is no perfect investment. Even an annuity, a common insurance product sold to retirees that can have guaranteed income, has downsides such as potential fees and a surrender charge if you pull the money out early. Everyone is different but a good retirement plan is going to balance these offsetting risks to give you the best chance of success.
When coming up with your plan, be aware of the pull of safety but also be aware of the longevity your plan needs to to ensure you aren't living like a broke college kid eating ramen (I was never a fan) in your final years. Let's chat on what I can do to help with your plan.