Stocks are inherently risky, and an investor has risk of capital loss.
As with most things in life, no risk yields no return.
Theoretically, the greater the risk, the greater the potential return. A new company which has not established itself yet will have a decent chance of crashing and an investor can lose all invested capital.
But — what if it takes off?
Your potential gains in such a situation are potentially vast. There is a point when the rate of increased return per degree of risk begins to slow down.
Logical investors are likely to seek the most returns they can get, within the confines of acceptable levels of risk. So, if given a choice between two investments with identical returns, and one is less risky, this is the one that would be chosen.
Investing money in stocks carries with it varying levels of risk, but ultimately, you must be prepared for the possibility of losing money. The market experiences both ups and downs, and it's important to understand that one cannot have the ups without the downs.
For example, if you invested $1000 in the S&P 500 index on January 1, 2000, you would have had approximately $740 more than 10 years later. As a general rule, investing money in stocks requires a long time horizon.
A buy-and-hold strategy in the S&P 500 only has a 0% loss history over 20 year time horizons—any lesser time frame has seen several periods of losses. Unless you are psychologically prepared (and please be honest with yourself) to experience significant volatility of your portfolio, you should not invest large portion of your assets in stocks.
It has been said that most long-term investors need to be prepared to lose half of their account value at least once during their lifetime. A smart investor will already have come to terms with the reality of volatile price swings and will make the wise decision to ride out such temporary downturns.
Contrary to common belief, a lot of investors buy stocks high and sell them low. Studies have shown that the average investor acting alone has underperformed the market by around 5% annually over a 10 - 20 year time frame.
Most investors overestimate their risk tolerance levels, and might be better suited, and make better decisions with, a portfolio with a more conservative asset allocation.
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