Why Take Risk?
There are a lot of metrics that measure risk, but there is only one that really counts. It is your willingness to take losses to earn higher returns. That is the financial risk in a nutshell – losses due to bad advice, bad decisions, and bad markets.
If you want higher returns you have to take higher risk. That is the way the system works. Any financial advisor who claims he can produce high returns for low risk is lying or he is running a Ponzi scheme. Investment performance and risk joined at the hip. If want higher investment performance you have to accept higher investment risk. If you want low investment risk you have to accept low investment returns (Money Market, CDs, t-bills).
You already know stocks are the riskiest form of investing. That’s because the return of stocks is more volatile than bonds. That’s stocks are equity investments that impacted by the success of the underlying companies. Bonds are fixed income investments. They are not as impacted by the fortunes of companies as long as they continue to make interest payments.
Do the Math
You take risk to earn higher returns. If you have a bad year, and you are young, you have plenty of time recover. If you are older you have less time to recover. But recovery is deceptive. Let’s say you have a dollar and it declines in value to 50 cents. You performance is a negative 50%. To get your dollar back your 50 cents has to double in value, which requires a 100% rate of return. Consequently, good years end-up recovering losses from bad years. Net returns over long time periods can be zero. And, that is before you deduct investment expenses and inflation.
It would be great if you could earn high returns for low risk. But, only criminals and extremely unethical financial advisors offer those types of deals. You have to take risk to earn higher returns.