Risk means the possibility of losing some or all of your money. The higher the risk of a particular savings or investment choice, the higher is the potential reward.
The annual percentage return on your investment offers a clear-cut comparison.
Interest is one of many (sometimes convoluted) ways people can gain from betting on the markets. If your checking account offers interest, chances are it’s well less than 1% compared with almost 10% a year from the stock market on average over most of the last century.
That’s partly because you can’t lose the money in your (government FDIC-insured) checking account whereas stocks can suddenly and dramatically lose value, so that you could wind up with less than you put in.
Stock Market Slides:
- 9/11/2001: stocks lose more value than any single day in history
- 2008 financial crisis: stock market loses 37% of it its value
- 2012: Facebook shares drop tens of billions of dollars in market value over three months to less than half of their offering price
And, yet… the stock market has offered the highest average return on investments: 9.6% from the S&P 500, between 1926 and 2008.
That’s little consolation if you have to sell at the wrong time, be it stocks or houses, as people have been finding in the recent foreclosure crisis.
Duration is factored into risk and so effects return. (See “The Time Value of Money” section. You can take all your money out of your checking account at a moment’s notice, so it pays little to no interest. You’ll get more if you commit even to a one-year savings account or a Treasury bond for at least 10 years—the best investment after stocks, some say.
You’re taking the risk that you won’t need that cash. If you do, penalties might leave you worse off than if you’d never invested.
Diversify: Another kind of risk is having all your money in one kind of investment—say, property, in case that drops. Don’t put all your golden eggs in one basket. (See “Savings vs. Investments”. (Ed Note: link))
Strange But True:
Women make better stock investors because they stick with what they’ve got despite market ups and downs, whereas men tend to switch. (We’re waiting on the follow-up study on TV-remote behavior…)
–Barclays Capital and Ledbury Research, 2011 study