Not Taking Risk is Biggest Risk & Stocks are Safe Investment Options

rss

Not Taking Risk is Biggest Risk & Stocks are Safe Investment Options

Stocks sometimes also known as Equities are the hot topics in the finance industry. According to some financial experts, it is one of the risky things but then again the main motto of the financial repression is "Not Taking Risk At All Is The Biggest Risk".

There are two schools of thought:

  • Stocks and Equities are big risk.
  • In comparison with Bonds; Stocks / Equities are more secure

ROLE OF STOCKS OR EQUITIES IN THE LONG RUN

Every once in a while, you check newspaper and read the news of the new highs in the Stock Market and you end up thinking why didn't you invested more? Your hesitance can be explained by the famous theory of the Stock Market, the Behavioural Finance. According to Behavioural Finance Theory, the investors are more inclined towards fear of loss and less towards the excitement to gain which is why they at times do not act rationally.

The burden of carrying the loss is more difficult than getting their hands on the additional income. This is the reason some investors simply shut their eyes close and stop seeing the long term role of the Equity. Equity Investment has a potential of more growth over the investment period as compared to some top-rated Government Bonds Investment.

THE GROWTH STORY OF THE EQUITIES:

There is nothing surprising about the success of the equity in the long run. If you dig into the foundations i.e. Macroeconomic Growth, there has been a huge growth in the mass prosperity especially in some of the industrialized countries, in the past 200 years. The measurements of the real Gross National Product (GNP) shows that since year 1800, there has been an average annual growth rate of approximately 4%, 3% and 3% in the industrialized countries such as United Kingdom, United States of America and France respectively.

Not so long ago, Shareholders were the one who benefited most out of this prosperity. The reason behind it was their Stocks which represents their share of the equity capital which is the key behind their participation in the most productive assets. There is hardly any other type of Investment Option that can bring same type of opportunity.

If you dig the past in USA, you will notice that different company's earnings have increased almost 4% since 1900.

stock and equity development

There has been a fair share of crises faced by companies during past centuries including the 1871's Founder's crisis and 2008's debt crisis. However, during and after crises, the companies learnt an important lesson i.e. crisis are part of the prosperity. According to Joseph Schumpeter, the art of destroying something that is old is a way of creating something new.

With the increase in the earnings of US companies, the prices of the equities also went up in US Stock Market. During the period from 1871 to 2015, the price index of S&P (Standard & Poor's) 500 went from 4.44 to almost 2,071.18 points. The increase in the price index is equivalent to increase of approximately 4.33% p.a.

Putting it in simple words, if your forefathers had invested not more than $100 back then in the equity portfolio, you would now hold an asset of more than $18 Million today.

This is the reason Equities investment is considered to be a Success in the long run even if it is nerve racking for some investors. In the long run, equities can bring in more profit than the bonds.

So, Investing in Equities was a success even if it did test the nerves of investors. Over the long term we can, moreover, see that equities actually have provided greater returns than bonds.

STOCKS AND EQUITIES SAFER THAN BONDS

This theory is stimulating. It highly depends on the investors and their definition of the safety and risks. And on investment horizon that is in question. When it comes to the risk of some asset class, it is usually measured keeping in minds the range of volatility or fluctuation. Keeping this as a benchmark of the risk, then it is safe to say that the equities were found to be much more risky in some cases as compare to any other type of investment option.

No one can deny the fact that the risk of loss for the Government Bonds is much low as compared to the Equities. However, the other side of the picture also tells us that the profit was also less in comparison with equities.

WHY EQUITY INVESTMENT?

It is not possible to completely eliminate the risk. However, it is also not impossible to manage it. The importance of timing in investing in the equities is less if the investment horizon is long. To explain this face, let's take an example of a person who prefers to use his savings and make them work for a period of almost 5 years has chances of suffering from more loss as compared to a person who went with a period of 10 years. To support the example, calculations using the stocks (US) from S&P 500 are taken as a sample. If you look at the figure below, the performance of the company was measured from the year 1800 for a systematic period of time i.e. 5 years. 1916 to 1921 is the worst case scenario in which the average loss was above 11% and during the best case scenario that is from 1924 to 1929, the earned percentage was approximately 27% or less.

Moreover, it is interesting to see the government bonds of 10 years also suffered a great deal of loss for over 5 years. Only if investors would define the term safety in reference to the purchasing power preservation instead of the share price fluctuation, there is a huge possibility that Equities would have been proven to be much safer than the Bonds during the horizon investment of 10 years or more.

Fluctuation Ranges of Different Asset Classes Since 1800

Asset Classes Fluctuations

Highest / Lowest Value in Rolling Investment Periods of Different Asset Classes (1800 - 2015)

The analysis done of 10 year systematic average of last 215 years indicates that negative outcomes were less dramatic for the equities as compare to the outcome of the short as well as long term official government bonds. 

During the peak period that was from 1949 to 1959, the chances of earning for an average shareholder were 17% p.a. and the average loss would be only 4% p.a. during 1911 to 1921 i.e. during World War One as well as from 1965 to 1975 i.e. first oil crises. However, the bond holders from the US would have faced a huge loss i.e. -5% p.a. during 1971 to 1981, because the inflation rate was going high at that time.

RISKS OF STOCKS AND EQUITY:

If you do a much closer and deep analysis of time from the past systemic 30 years or so, you will get to know some of the very interesting facts when it comes to investing in securities. The risks for the Stocks vs Bonds (Government) that are received in the consideration by a shareholder, for example, of higher but short term liability or fluctuation risk. An average yield for more than last 215 years was almost 3.7% p.a. however, it did went to a lowest level i.e. -0.4% p.a. from 1981 to 2011 which means that the shareholders and bond investors were on the same page during this entire phase despite having some of the highest levels of the volatility.

If you go on and do further analysis of key drivers of the market returns of equity, you will see that the risk fluctuation happens to be not so surprising. The risk premium i.e. the long terms one of the stock market must have been made up from the conflict between risk free interest rate, equity return, inflation, credit as well as time premium and the variables that keep changing over the period of time.

So according to the history, it is safe to say that the theory seems to be right that people who prefer to take risks are more likely to enjoy the advantages that comes from the risk premium in long run.

A further analysis is to break down the performance of the stock market into contribution to the returns.

The Components Results From:

  • Contributions made from the dividends
  • Earning growths of the company
  • More than one expansion in stock market

Global Capital Markets

Source Idea: Worldwide Contribution by Equity market Region from Capital Markets: An Engine for Economic Growth from Geert Bekaert and Campbell R. Harvey, Duke University.

HOW TO INVEST IN THE STOCK MARKET?

If you are beginner and decided to start investing in stocks, the biggest question for you will be "How to Invest in Stocks?" To start investing in stock market you will need licenced third party broker through which you will be allowed to Buy and Sell Shares in the stock market. Now, the second question for you will be "What Stocks to Invest In?" When you are looking for long term investment it's very important to find best stocks to invest in, for this you will have to do some research about the companies'.

How to Pick Stocks?

  • The first thing you will have to do is Fundamental Analysis of the company. Fundamental analysis means you are analyzing the company's performance in terms of revenue, expenditures, liabilities etc. This analysis gives you the clear idea how the company is performing and how it will perform in long term. As an investor you will never invest in the company who is not making profit therefore it is very important to find the companies have strong fundamental values.
  • Now if you don't have much knowledge about Fundamental Analysis then the second thing you can do is look for the companies' stocks who have large Mutual Fund Holdings. Mutual Funds are operated by the experienced and highly professional financial experts who have complete knowledge about the stock market. Mutual Fund Managers invests large number of investors' money in the stock market and fund manager have the responsibility to make profit out of it. If Mutual Fund Managers are picking some companies stocks for long term investment it means that the company have strong fundamental values.
  • The third thing you can do is to pick Blue Chip Stocks, It is the more safe option for you as beginner. Blue chip stocks are of the companies who are well established and financially performing better and better over the period of time. This kind of companies have large market capitalization and it can be in billions of dollars.

FINAL VERDICT:

Keeping in mind the fact that inflation might end up eating all the purchasing power, it is safe to say that the investors who are willing to double their overall wealth are not the biggest risk takers. For the investments that are made in Government Bonds and Fixed Deposits, the risk is more likely to get strong instead of getting weaker in current low interest environment, expectations of the interest rates rising in the long run and threat of the price lose.

On the other hand, equities are more likely to gain success, only if the risk premium attractions continue to appear attractive. Moreover, the investors should focus on the long term benefits while making their strategy for the asset allocation.

The head picture of this article shows a man who does not understand why his performance is negative. He has invested in very safe assets (Government Bonds with Negative Return) only but at the end he ends up with a loss after negative return and inflation. This is even true for many money market funds or promotional offers from banks. You can easy end up with less money.

Try Ways2Wealth's free portfolio builder tool, and check how your portfolio has behaved in the past years and how much your historical maximum loss was and decide yourself how much risk you can swallow. Our Portfolio Building Tool is free to use and you can use the recommendations to invest online or at your local bank or local broker.

 





Comments are closed.
Showing 0 Comment



Build the best diversified online ETF portfolio with help of the Ways2Wealth portfolio tool. Investing in shares without a independent financial advisor and take your wealth management in your own hand with this online investing tool. No further financial advice or investment funds is need for professional portfolio management. Try the asset management tool and you never have to ask yourself how to invest money again.

How to develop a diversified online finance portfolio