Investing is scary. It requires you to put your hard-earned money at risk, without much control over what might happen. And yet, millions of Americans who are not professional investors hold securities in 401(k)s, IRAs, and brokerage accounts. For those folks, the rewards outweigh the risks.
That's not to say these investors ignore those risks. Ignoring the risks of investing sets you up for disappointment. On the other hand, cultivating a healthy respect for investing risk usually makes you a better investor. You'll actively manage your risk and, hopefully, be more prepared when the market hits a rough patch.
Ready to check your own level of respect for investing risk? Here are two reasons to fear the stock market, and three reasons not to.
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1. You fear losing money
History has taught us to respect the downside of stock marketing investing:
- On Black Monday in 1987, the S&P 500 index lost more than 20% of its value in a single day.
- After the dotcom bubble burst in 2000, the Nasdaq tech index fell more than 75% in less than 18 months.
- Between 2007 and 2009, the Dow Jones Industrial Average fell more than 50%, thanks to a global financial crisis.
- The short-lived coronavirus crash of 2020 slashed nearly one-third of the S&P 500's value in three months.
There's no getting around the fact that you can lose money in the stock market -- and in short order. Both long-time investors and novices know this, but only the experienced investor has more confidence that the risk of loss can be managed.
Two strategies to manage the risk of investing loss are:
- Only invest money you don't need for five to 10 years. The market moves in cycles. If it's down today, it will eventually go back up. That was the case for all four crashes listed above and every other big downturn in history.
- Hold different kinds of stocks plus bonds and cash. This way, your wealth doesn't rest on one stock, one type of stock, or even one type of investment.
2. You fear unpredictability
The whims of the market can be unpredictable, even to economists and investing gurus. That's unsettling. After all, the point of investing is to meet a future financial goal. You could meet your goal only to see the market crash the next day.
The funny thing about the stock market, though, is that it's terribly unpredictable in the short term -- while also somewhat predictable in the long term. In periods of 10 years or more, the market normally rises. In periods of 20 years or more, the market has always risen. Those patterns could change in the future, but most investors assume they won't.
Two ways to manage against short-term unpredictability in the stock market are:
- Keep cash savings alongside your investment portfolio. If the market dips temporarily, use the cash for emergencies instead of selling your stocks.
- Again, only invest money you don't need for five or 10 years. Give yourself the opportunity to ride out a downturn.
3. You want to make money
Investors accept the risk of loss and the stress of unpredictability for one reason: to make money.
The long-term average growth of the stock market is about 10%. That's about 15 or 20 times more than you'll earn in a cash savings account. And if you account for inflation, the comparison is even more lopsided. Inflation brings stock market returns down to about 7% and puts cash earnings into negative territory.
It doesn't take investing brilliance to access market returns, either. All you have to do is invest in the best index funds. Here's how that works. The S&P 500 is an index that's used as a benchmark for the entire stock market. When someone says, "the market rose 2% today," that usually means the S&P 500 rose 2% today.
An S&P 500 index fund is an investment portfolio that mimics the behavior of the S&P 500. When the S&P 500 rises 2%, the index fund also should rise about 2%. Any difference in performance between the index and the fund should mostly be related to the fund's expense ratio. If you choose a fund with a low expense ratio, your returns should be very close to market level.
4. You know long-term investing losses are uncommon
As I noted above, the stock market usually rises during periods of 10 years or more. The longer your investment timeline, the easier it will be to turn a profit.
You might see a 20% rise in one year and a 20% loss in the next. But if you can ride out that turbulence, your investments should appreciate over 10, 15, and 20 years.
5. You understand crashes and corrections create opportunity
When your favorite brand of shoes or clothes goes on sale, you view it as an opportunity. You can get more of the stuff you want at a lower price.
Stock market crashes and corrections have a similar dynamic. When the market dips, good stocks go down in price. That gives you the chance to add to your share count without spending as much of your cash. And when the share price eventually rebounds, you should be sitting on a nice gain.
Uncertainty is a factor here, of course. You don't know when the rebound will happen. That's why investors pursue the strategy of buying in a downturn cautiously. You have to be 100% confident you won't need that cash anytime soon.
Face your fears while managing risk
If you can face the fear of investing and manage the risks, there's money to be made. Diversify your portfolio with different types of securities, and keep a sum of cash on hand for emergencies. And importantly, don't invest money you'll need in the next five years. Even better, plan on leaving your investment account alone for at least 20 years.
Those actions combined limit your portfolio's volatility and set you up to ride out any market craziness that comes your way.
