Are you too risk averse? If so, it's time to check yourself.
We human beings are programmed to avoid negative outcomes at all cost -- after all, if our ancestors had lacked a healthy fear of saber-toothed tigers and other prehistoric hazards, we wouldn't be here today. So in a way, being risk averse makes all the sense in the world.
And yet, in the modern world, we have to take certain risks if we want to live out our days in comfort and financial security.
The root of the problem
In 2001, Roy Baumeister, then a professor at Florida State, wrote an article titled "Bad is Stronger Than Good." Baumeister found that our reactions to negative experiences are far more psychologically powerful than our reactions to positive ones. "Bad events are so much stronger than good ones that the good must outnumber the bad in order to prevail," writes Baumeister. "[An index] suggests that bad events are on average five times as powerful as good ones."
Given how deeply negative experiences can affect us, it should be no surprise that many of today's investors, especially millennials, are risk averse. If negative events are more powerful than positive ones by a five-to-one margin, then the psychological damage of the two market drops below were more than enough to scare investors away from stocks altogether -- despite the fact that stocks have delivered superior returns over the long term.
This won't end well
When it comes to investing, complete avoidance of risk is actually a maladaptive behavior. A recent report by the Brookings Institute found that those between the ages of 21 and 36 were hoarding their cash -- mostly in low- to no-yield instruments.
Source: Brookings Institute, UBS Wealth Management 2014.
In a perfect world, these roles would be reversed. Given that they have far more time before they retire, millennials should be putting far more into the stock market than their parents and grandparents. While the stock market is certainly volatile, buying and holding for years has a way of smoothing things out -- and producing unbeatable returns.
Over a long enough time frame -- remember, your investing career may last 50 years or more -- stocks outperform bonds and money market funds by a wide margin.
For example, let's say you had $1,000 to invest 40 years ago. Since then, the stock market has returned an average of 10.9% per year, while the average 10-year bond has returned 7.5%. That may sound like a small difference, but compounded over 40 years, it's astronomical.
What's missing from this picture are the dips. Because I only updated the values every 10 years, we don't see the same dives that are present in the first graphic in the article. That's why adopting a hands-off, buy-to-hold strategy to investing in the stock market can be so important: It stops you from selling out when times get tough.
Stop being risk averse -- start investing now!
If you're reading this and you still have over two decades until retirement, there's no way you should have half of your savings in cash. While you still have time on your side, contact a financial planner and come up with an approach to investing in the stock market that you're comfortable with.
And if you want to try the DIY route, check out more of our free content here on Fool.com and check out the special free report below.
