How Risky is Investing in the Stock Market?
Updated: Jan 30
What you will learn in this article:
When investing in the stock market, it's natural to feel a little uneasy. After all, the media often focuses on the market's downsides, painting a picture of constant volatility and potential losses. But despite the risks, investing in the stock market can be a powerful tool for achieving financial independence. In this blog post, we'll take a closer look at the risks of investing in the stock market and explore some strategies for minimizing risks and maximizing your returns.
Let's Break it down:
1. The Risks of Investing in the Stock Market:
There are many ways to invest in the Stock Market. To simplify these explanations of risks, I will focus on the two primary ways most investors invest in the market: individual stocks and mutual funds/exchange-traded funds.
Investing in an individual stock is when you pick one particular company and buy shares in that company. In other words, you become a part owner! For example, if you buy one share of Apple stock, you become a part owner of Apple. However, there is a considerable risk in buying individual stocks. The risk is that you are betting solely on the success of that company, and if something happens that is out of your control, you are heavily impacted. Back to our Apple example, let's say a war with China breaks out, and you invested in Apple. All of a sudden, Apple loses access to producing cheap iPhones. This would destroy their stock price and, in turn, your investment.
Investing in individual stocks can generate massive returns over the long run. Just look at Elon Musk, Mark Zuckerberg, and Jeff Bezos, who have all their money tied up in their company's shares. However, individual stock investing carries many risks and is only advised for people if they are prepared to experience a lot of volatility and potentially significant loss.
The next option we will be discussing is investing in funds. This is a much better option for most investors and especially those that do not want to worry or stress about their investments.
A fund is a group of stocks pooled into one fund. For example, VOO is Vanguard's S&P 500 Index fund which tracks the 500 most prominent companies in the U.S. and has their stocks in one fund. While risks are still associated with these types of investments, it provides a high level of diversification. In other words, it spreads the risk across all 500 companies.
Back to that Apple example, if a war breaks out with China and you have Apple in your fund, the effect on your money will be minimized dramatically because you will have 499 other companies that will be fine or, in some cases, benefit from the war in China resulting in less of a loss.
Investing in funds provides less upside than individual stock, but as stated in the example above, it is much less risky. There still are risks with investing in funds, and some funds will focus on specific industries, so be sure to research each fund's holdings before investing in them. Investing in funds is a great way to grow your wealth over the long run without an insane amount of risk.
If you need a better idea of what funds to start with, check out our article here.
2. The Key to Investing is Time:
The most important thing to determine when investing in the stock market is, without a doubt, your timeline.
The stock market can be highly volatile in the short term, but it has historically trended upwards over the long term. This is why it's essential to consider your timeline when investing in the stock market. Below is a graph of the S & P 500 from 1950 - 2016. What you will see is that over 1-year periods and 5-year periods, it can be very volatile, and you are at risk of losing money. However, this risk becomes much less once you reach a 10-year time frame.
In fact, never in the S&P 500's history has a 20-year investment resulted in a loss when investing in an S & P Index fund. You would also have generated a minimum of close to 8% annually that will compound on itself which means your money would have grown and compounded over that time.
Source: S&P 500 - Wikipedia
Key Thing to Remember: When investing for the long run, it is key not to pull the money out even when the value decreases. In fact, that is when you should always be investing more.
3. What is best for you?
This is great to know, but how does it apply to you? The answer is that it ultimately depends on your goals. That being said, investing in the stock market is the key to retiring wealthy and reaching your financial goals. If you are young and not taking advantage of the time you have to grow your investments, you are missing out on millions of dollars in the future.
Always ask yourself when you need the money when determining whether or not to invest.
If the answer is longer than 5 years, investing in an index fund might be an excellent option. On the other hand, investing in individual stocks can be very risky and is only recommended for people willing to take on that risk and willing to potentially lose their investment.
4. Where to Start?
The easiest place to get started is with retirement accounts such as a Roth IRA or a 401(k)/403(b) through your employer. These accounts will provide a great avenue to start investing and won't let you touch the money until 59 1/2. An employer plan is great because it usually won't let you invest in individual stocks.
You can also open a Roth IRA or a brokerage account at a company like Vanguard, Fidelity, or Sofi.
In conclusion, investing in the stock market is risky, but that can be mitigated through time and diversification. It is the key to generating long-term wealth and is almost a requirement for most people to escape the middle class. For the average person, investing in funds is the way to go and can offer the least risk-to-return ratio while still having exposure to long-term growth. Always consider your timeline and understand the risk of investing for lengths of time under 10 years.
Remember, you should always be investing, whether in a retirement account or just a normal brokerage, as you could be missing out on millions in gains and your potential to retire.
Keep in mind everyone's financial situation is different, so always consult with your financial advisor or a tax professional on specifics, but this should provide a great starting point for understanding the risks of investing in the stock market.
As always, feel free to contact us with any questions as well.