What's the first word that comes to your mind when you think about investments? For many people, the word is risk. But what does that word really mean?
Financial planners look at many different kinds of risk. People who have all their money in CDs and money market accounts may see the relative value of their accounts fall if the rates they get on their money can't keep up with inflation. This is purchasing power risk.
People who put money into bonds may find that the value of their bonds will drop if interest rates rise. That's interest rate risk. Bonds and other investments also suffer from the risk that the companies or municipalities that issue them may default on their obligations and not pay you. That's financial or default risk. But the risk that most of us think of when we think of investments is market risk. Market risk is the chance that you'll lose a substantial amount of money on your investments because of a sudden change in the financial markets or to an entire class of assets.
There is a great fear of a sudden downturn in the financial markets, particularly the stock market. Everyone has heard stories of the crash of 1929. Then there was a big market downturn in 1973 and 1974, and sudden, abrupt drops in 1987, 1998 and 2001. That's the thing about the stock market. There are times when investors may lose a lot of money. It is very hard to predict when the downturns will occur and it is even harder to predict when the market will recover.
There's no crystal ball, and the bulls and the bears fight it out daily on Wall Street.
We can tell you that stocks, particularly stocks of small companies, have done better than any other kind of investment over the long term in spite of market downturns. But it is important to understand that past performance is no guarantee of future performance.
Ask yourself... how much of the ups and downs of the market can you take?
IT'S NOT A GOOD INVESTMENT FOR YOU IF YOU CAN'T SLEEP WELL AT NIGHT.
Your job as an investor is to find the combination of safety, liquidity, and growth you are comfortable with. You need to find out how much risk you can tolerate.
