How risky is the stock market?
|Date:||18 January 2018|
|Author:||dr. Lammertjan Dam|
Stocks can be an attractive investment. At the same time, many people are reluctant to invest in stocks, as they fear big losses due to the riskiness of stock market investment. With financial crises in mind, they rather avoid suddenly losing almost half of their outlay. However, is this fear reasonable? It seems that the risk associated with stock market investing is not well understood. People are aware of the fact that stock market prices go up and down a lot, but commonly they do not grasp what to really expect in terms of risk. Financial professionals use jargon such as volatility, systematic risk, alphas and betas, etc., but many private investors often do not understand these concepts, and if they do, they may lack an intuitive understanding of what the levels of these risk measures imply in practice. We prepared a brief research paper, where, we shed some light on how much risk one can expect when investing in the stock market. In particular, we highlight and visualize the differences in risk and return between short-term and long-term investing.
In sum, yes, investing in the stock market can be risky. Investors facing an investment horizon of five or ten years are likely to do well, but should accept the risk that they end up with somewhat less than they initially invested. But for a 20 to 30 year investment horizon, the stock market risk comprises almost exclusively upside risk – not downside risk. It is extremely likely that your return will be far better compared to putting your money in a sock, or in a bank account with a low (real) interest rate. So if you are in your 30s or 40s and want to save for retirement at 65 or 70, realize that the risk of stock market investing is not as severe for such a long time period compared to the “craziness” in daily price fluctuations.