Investment Risk is More Than Losing Money

By | 2016-08-31

Figuring out where to put your money can be a confusing and stressful undertaking. Recently, a reader that has stayed away from the stock market asked “how to get comfortable with the thought of losing money.” That is a very good question that comes up a lot in other investing conversations I have had. It spurred me to turn my thoughts on managing Investment Risk into a post.

Investment Risk is More Than Losing Money (1)

Understandably, people are scared to lose money. You work hard to earn it, and make sacrifices to save it. The last thing I want to do is watch my balance drop due to something outside of my control. However,from my perspective, a bulk of the fear is overblown. People feed off other peoples fear. Here are a few real world examples I have seen:

“Our friends lost half their money in the stock market”

 “If you’re investing in the long term you’re crazy”

Any day of the week doomsday predictions are thrown out across a ton of media publications. If that is your only experience with the investment world, I see why you would be scared. It does not take a lot of fear to paralyze action, it is a powerful emotion.

Classic View of Investment Risk

There is not a one size fits all approach to determining appropriate investment risk. Most advisors/risk assessors use a combination of the below factors:

  • Age – The younger you are the higher risk you can take on (generally)
  • Years to Retirement – I think this is a lot better gauge than age, the closer you are to retiring the more protective you should be of your nest egg.
  • Financial Security – If you are in a great financial position already you can afford to be more aggressive.
  • Personal Risk Profile – There are tons of risk profile questionnaires that place your personality in a category. It is hard to quantify this portion, it is more of a “can you sleep at night” gauge.

From there people are placed in a investment category, the correlates to a percentage based mix of stocks and bonds. The typical ones are:

Conservative <-> Moderate <-> Aggressive

Conservative portfolios are aimed at maintaining your nest egg, and have more bonds. Aggressive has a higher stock allocation (usually 75-90%) and is aimed at portfolio growth. The A.E. household rocks a 10-15% bond allocation depending on market fluctuations. I prefer to be right in that 10% range for the foreseeable future.

Then there is the infamous “Gut Feeling” approach where you skip all of the logical thinking and select aggressive because it sounds good to you (that was my approach when I filled out my 401K for the first time 5 years ago).

Another Way to Look at Investment Risk

The historical returns from investing can’t be ignored, a balanced portfolio from 1926-2015 returned 8.7% on average (60% Stocks, 40% Bonds)*. If you are investing for the long term, investment risk drops dramatically. Markets have recovered from every correction, setback, and bubble.

*See this page for the breakdown of other portfolios and best/worst years  https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations

Instead of worrying about short term paper losses, I look at investment risk from a different angle:

“Are my investments going to return enough so I have enough money to retire and never run out”

In other words, are my investments mitigating the risk of running out of money?

Quick peak at common return rates and what they do to a $1,000 over 30 years

Investment Risk

The percentages were pulled on 8/24/2016 and reflect the best available for Online Savings Accounts and Long Term CDs (5 years). It is difficult to ignore the Stock Market Returns column (which does include some bonds) compared to the rest of the lot.

140 years to double your money at .06%….Please don’t keep a sizable amount of money in a traditional savings account, it is a Common Money Mistake You Can Correct in an Hour

Going to use this as an opportunity to tell a personal story that shows what can happen if you don’t build a large enough nest egg.

My Grandma is essentially broke at 80 years old. She is currently living with my parents in a spare bedroom because she could not afford her townhouse. While this is not that uncommon, the reason I bring this up is she wants to be independent, but is unable due to her financial situation. Our family has come together to help her, and that is GREAT – but its not on her terms.

At a minimum we want to be able to fend for ourself financially until the day we are both gone. I want my future children to depend on us if they run into financial problems – not the other way around.

We are counting on investing returns to expedite Financial Independence and build a pile of cash that will last forever. Without using a mix of stocks and bonds, this would not be possible at our current income projections. To put it simply, we wouldn’t be able to save enough with risk free investment gains to meet our goals. There is a bigger financial risk using CDs vs a balanced investment portfolio.

Is the thought of losing money keeping you from building a size-able nest egg?

The best advice I can give you to get over the fear of losing money is to continue reading success stories and researching historical gains. If you continually invest over long periods of time in a diversified portfolio you should be able to sleep at night.

Another method I use to ease the fear is Dollar Cost Averaging. Think about how many more shares you are buying when the price drops.

Instead of thinking “I can lose money” ask yourself “Can I afford to ignore investment gains?”

Losses aren’t real until you sell! If you can ride out the storm you technically did not lose any money on that transaction.

If you are still on the fence, build up a sizable Emergency Fund first then start moving your money into a mix of stocks and bonds. Personally, I rarely invest in individual stocks – the risk outweighs the reward for me. I am a huge fan of Vanguard funds due to their low expense ratios.

For the readers on the opposite end of the risk spectrum – take a look at My Stint as a Day Trader for some advice.

 

Some products that can help you:

Personal Capital: Personal Capital has a ton of great Free features, you can track your spending, net worth and even analyze your portfolio. It has top notch security and I am able to connect all of my accounts. Saves a ton of time!

Sofi – I saved a ton of money using SoFI for a Student Loan Refinance. They are great to work with, the process was super easy (compared to my previous refi) and I got a great rate. If you have student loans be sure to check them out.

Disclosure Policy

43 thoughts on “Investment Risk is More Than Losing Money

  1. The Green Swan

    You are right on, people have a lot of emotion when investing in the stock market is brought up. Too many people have shunned the market since the 2008 a recession and missed out on a strong and long-lasting bull market. I tell people to have faith in the long term performance, and like you said, how can you afford not being in the stock market!

    Reply
    1. Apathy Ends Post author

      Thanks for the comment Mr Swan

      A long and strong bull market indeed – some people are starting to feel invincible.

      Reply
  2. Linda @ Brooklyn Bread

    I’m always surprised at how many people are afraid to invest their money. I don’t think it is possible to become financially secure without it. (Unless you are born rich, of course!) But I suppose it just seems frighteningly complicated and confusing if you have no frame of reference. I’ve always taken advice from my dad who became an astute investor in his retirement, a foundation that gave me confidence to do my own research. No one should be losing everything in the stock market. If they did, they were day trading and investing in risky equities that they were not educated about. Anyone can take advantage of low risk index funds, which have performed pretty incredibly the last few years. This is an excellent primer for beginners and I hope it helps inspire anyone who is not investing to do so!

    Reply
    1. Apathy Ends Post author

      Thanks Linda, awesome to hear that you dad was able to pass down a solid foundation of investment advice. Having the confidence to put your money out there plays into this as well. The more success stories you hear the more confident you are in your decisions.

      Reply
  3. Matt @ Optimize Your Life

    After spending a lot of time in the personal finance space it is always surprising to return to the real world and remember how many people are afraid of investing. They remember the collapse of 2008, but not the bull market that followed. This is a great re-framing of the issue for people that are having trouble getting started because of that fear.

    Reply
    1. Apathy Ends Post author

      haha – outside of our Personal Finance bubble money sense drops off significantly, hopefully everyone stumbles across one of our blogs sooner than later

      Reply
  4. The Financial Panther

    Interestingly enough, I find a lot of my friends on the completely opposite end of the risk spectrum. We all graduated college in 2009 and 2010, so while we felt the economic effects of the financial crisis (none of us could get jobs), we were fairly insulated from the investing effects (since we had no money to invest and none of us were investing at the time).

    Because of this insulation, alot of my friends take far too much risk, since we’ve never really experienced a crash ourselves. They also spend far more time on their investments then I do. It’s good to understand your risk on both sides. What’s the opportunity cost of not investing and what’s the risk of taking on too much risk. After all, in the end, you just need to take on as much risk as necessary to reach your goal.

    Reply
    1. Apathy Ends Post author

      Outside of a few corrections in the last year I have not experienced a major downturn either. I have lost money trading stocks I know nothing about though.

      Thankfully the stock markets history is well documented and you can prepare yourself for the ups and downs. Taking on to much risk is a huge mistake, especially if you aren’t outperforming the market. Which very few people can do.

      Reply
  5. Dollar Engineer

    I agree with you on this one AE. The risk of not investing and having your money sit in a savings account vs. work for you long term is too great. Also, actually reading up on historical performance rather than listening to singled out disaster stories will help ease the fear of someone nervous about losing their money. While investing is always a risk, which you acknowledge, it’s just a matter of investing what you are comfortable with in my opinion.

    Reply
    1. Apathy Ends Post author

      Those disaster stories do a lot of damage, it is way easier to get people to click on turmoil than a slow steady investment gain.

      The brick and mortar bank interest rate on savings accounts is criminal

      Reply
  6. Ms. Montana

    It can be scary for people. I remember my coworkers pulling all their money out of the stock market after it crashed. I’m not sure they ever put money back in. Even Mr. Mt was nervous when I started dumping our cash into more stocks. Seeing thousands of dollars disappear made his stomach turn, after we had worked so hard to save that money. But that choice helped us pay cash for our house. And then go on to buy investment properties. You just have to hold on and try not to throw up in the process.

    Reply
    1. Apathy Ends Post author

      It would be really interested to see how many people actually pull their money out and when they get it back in (if ever) – the double slap in the face of missing out on the bull market would make me go insane

      Reply
  7. Divi Cents

    Having invested all through the great recession I can tell you it can be scary as hell. I had days when my stock would drop 30% in a DAY!

    It was crazy. I saw my portfolio go from 80,000 down to 30,000 in a matter of months.

    Every talking head was saying don’t sell, they were screaming it (although they who were talking had already exited their positions. I’m looking at you Jim Cramer and Bear Sterns!)

    The only saving grace for me was at the time I was still working so I bit down on my mouth guard and started buying everything in sight. In less then a year my $30,000 was back up to over $80,000. It was not easy buying stocks at that time but in hindsight I wish I would had bought 1000x more.

    Reply
    1. Apathy Ends Post author

      That is a nasty drop – and its always fun to find out who is preaching a position after they did the opposite themselves.

      Its funny to look back and think about how much more you could have bought, at least you bought some and weren’t selling low

      Reply
  8. D
    Doug

    Yup you might get sick in the stomach during a prolonged bear market, it just means awesome buying oppurtunities. I’m literally seeing the dividends from some purchases during the down turn. Lol

    Reply
    1. Apathy Ends Post author

      I got caught day trading a few years back and was sick to my stomach – it was a good lesson and thankfully not to expensive.

      Thanks for the comment and read!

      Reply
  9. Jon @ Be Net Worthy

    This is good advice AE and it is amazing how many people are afraid to invest. It’s sort of like paying for college, think of the cost of NOT going…

    Good stuff!

    Reply
    1. Apathy Ends Post author

      Thanks Jon, fear paralyzes (along with apathy)

      Reply
  10. [email protected] Smarter Decisions

    We are actually a bit afraid to invest right now because we are going to use a lot of our retirement money to bridge the gap until I collect my pension. We are very conservative because we know what we need the money for – so we are fine with it. I did go back to your post on day trading and would love your opinion on something. My son wants to try (say $50-100) on trading through something like Robinhood. Have you heard of that? And will the money be a good lesson on why to just use index funds? I thought it might be a cheap way to teach him… (this is his idea – and he is thinking of going into statistics/finance in college). Thanks 🙂

    Reply
    1. Apathy Ends Post author

      I have heard of Robinhood, they do free trading I believe and I remember Google investing in them at one point (probably over a year and a half ago).

      Even though I don’t recommend day trading, it is a great way to learn how the market works. I cared and learned a lot more actually having money in the game – even though it was only $300. Trading takes constant research, worse case scenario is he loses $100, that is a pretty cheap lesson in my opinion.

      Reply
      1. [email protected] Smarter Decisions

        Yep – it’s free trading and we talked about linking an account that only has $100 and if its gone – then its gone. It scares me that at 18, he could link a bank account that I have no control over. He is 17 for a few more months – might be time for an experiment! Thanks for your thoughts 🙂

        Reply
        1. Apathy Ends Post author

          Haha, ya it might be better for him to get it out of his system now. If he has questions or wants a few tips feel free to send him my way!

          Reply
  11. [email protected]

    A group of docs was talking at lunch yesterday about buying gold because the stock market is volatile and they want to have security for when our whole economy implodes. They told each other to be sure to buy gold coins because it’ll be harad to shave a few ounces off a bar of gold each time they want to make a purchase.
    I almost choked on my food.

    Reply
    1. Apathy Ends Post author

      haha, that is awesome.

      Gold has been just as volatile as the rest, funny how people perceive the market

      Reply
  12. Tawcan

    It’s odd that people feel better seeing the number in their savings account increasing ever so slightly than seeing portfolio value move up and down on a daily basis. One rule you should use is only invest money that you don’t need for the next 10 years. If you need that money you shouldn’t be investing in the stock market.

    Reply
    1. Apathy Ends Post author

      I agree Tawcan, if you shade to the conservative side build up your emergency fund and start putting away what you can live without. Then increase the amount you can live without 😉

      Reply
  13. Simple Money Man (SMM)

    It’s definitely true that “There is a bigger financial risk using CDs”. We’re all living longer nowdays due to better medicines healthier food options, exercise habits and general health awareness and prevention. So the fear of running out of money is REAL and risk can be very high if you play it too safe! Also in terms of balancing, retirement time horizon funds are a good option too for people who don’t want to allocate themselves and rather have the fund adjust stock and bond allocations as they get closer to retirement.

    Reply
    1. Apathy Ends Post author

      Good point SMM, I do like Target funds but find they are a little on the conservative side so I usually push my projected retirement date back a bit when I choose them.

      Reply
  14. Dividends Down Under

    Hey AE. You’re completely right. The risk of cash long term is very high, your money is almost certainly going to be eaten up by inflation.

    The only way to beat this is with investing in things that will increase their value and income. The S & P has been fantastic at this. Rental properties have been good. What the next 10 years hold will be very interesting, let’s see.

    Tristan

    Reply
    1. Apathy Ends Post author

      Thanks for commenting Tristan, inflation is a killer and unfortunately most guaranteed investments are eaten by inflation as well.

      Reply
  15. FinanceSuperhero

    “In other words, are my investments mitigating the risk of running out of money?”

    A very wise question, AE. I once had a family member argue with my then-18-year-old self about retirement risks. I posed a version of the question above, and the family member had no justification for keeping her money in CDs and savings bonds – yes, savings bonds.

    Reply
    1. Apathy Ends Post author

      haha, if CDs were still kicking out around 4% it wouldn’t be THAT bad but still underperforming.

      Thanks for reading/commenting Mr Superhero

      Reply
  16. Finance Solver

    Emotions are such a powerful force in driving the stock market. And it can definitely take its toll on someone who’s not used to the risk that brings. I used to stay up late at night not sleeping well the day that I started investing but have gotten so comfortable and used to it that I’m comfortable holding 3x levered ETFs overnight without blinking an eye. Oh how times have changed!

    Reply
  17. Amanda @ centsiblyrich

    Great post! The example of your grandmother is pretty typical. My parents are in their mid-60s and cannot retire because they were afraid of the “risk” involved with investing (plus they didn’t think they made enough money to invest). What they did do is pay off all their debt, so at least they have that.

    We lost half of our portfolio in 2008 and, though it was painful to watch, we just left it since we knew we had the luxury of time. Our recovery was great. Going through that experience has helped me so much when the market tanks and I see my account balances drop. Like many others, we keep as much of our investments as we can in low cost index funds (Vaguard).

    “Instead of thinking “I can lose money” ask yourself “Can I afford to ignore investment gains?” LOVE this!

    Reply
    1. Apathy Ends Post author

      Thanks Amanda, I should do some research around % of money invested by age group. Would be pretty interesting to see how conservative people are.

      Reply
  18. Investment Hunting

    Great side-by-side view of returns. I wish I’d put $1,000 into a savings account on the day I was born. I guess I need to lose some weight so I can make it to 158 so I can double my savings account ;-). Seriously, the spreadsheet shows how silly it is to put your money into low return accounts. Thanks for sharing.

    Reply
    1. Apathy Ends Post author

      Haha, it is pretty insulting to pay someone that small of an amount

      Reply
  19. Our Next Life

    Such an important way to look at risk! I used to be completely afraid to invest, and totally had that “I can’t afford to lose this money” mindset. It was finally coming to terms with inflationary risk that changed my view and made me get comfortable with market risk. Because I was guaranteeing a loss of spending power with every month I was invested only in my savings account!

    Reply
    1. Apathy Ends Post author

      Haha, glad to hear you got all of your money out of your savings account!

      I didn’t touch on inflationary risk and that is something people ignore – appreciate the comment!

      Reply
  20. t
    timeinthemarketblog

    I agree that the stock market is the way to go if you want to build wealth and keep it simple. The issue is with the time frame that people are working with. The stock market is the best long term investment but many people don’t see it as that and get scared off when the stock market drops in the short term. I worry about those people who have ridden the bull market since 2008 and haven’t really experience any massive market drops. Will they be able to stomach it all when it eventually happens, buy low and reap the long term rewards or will they sell at the wrong time?

    Reply
    1. Apathy Ends Post author

      Hopefully people are using an automatic investment strategy and they keep pumping money in during a correction.

      and yes, totally agree that your timelines should play a big role in how much money you have in the market – eventually you need to move from building to preserving.

      Thanks for the comment!

      Reply

Leave a Reply

Your email address will not be published. Required fields are marked *