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What's
the Price of Playing It Too Safe?
During the
past two decades, the stock market saw some pretty terrific returns. In 1980, a
$10,000 investment in stocks mirroring the S&P 500 would have grown to more
than $190,000 by April 2002. That’s a cumulative return of 1,806 percent!1
Most people correctly understand that the stock market is riskier than other
investments. For example, if you had invested $10,000 in 10-year Treasury bonds,
which are considered to be risk-free if held to maturity, you would not have
lost a single penny in any year since 1980. Meanwhile, the S&P 500 lost
value during five of those years. Yet the value of your bond investment would
have grown to only about $58,000 by April 2002, a cumulative return of 484
percent.2
Determining how much risk is appropriate for your portfolio is a decision you
must make. It will depend on your time horizon, personal goals, and other
factors.
Looking at this example from today’s perspective, taking zero risk would have
cost you $132,000. Had you known in 1980 what you know now, your decision
between the stock market and Treasury bonds would have been simple.
Of course, that’s pure fantasy. You have no way of knowing how the stock
market will perform over the next two decades. While there are experts who say
that stocks are overvalued today and high returns will be impossible in the
future, there are others who believe that stock investors will be rewarded.3
 If
your investment goals are years away, you may be able to assume more risk than
others who plan to access their money much sooner. As you get closer to your
investment goal, you may want to shift to more conservative investments because
you will have less time to recover from a potential loss.
The amount of risk that’s appropriate for you will depend on a range of
factors. Knowing your risk tolerance may help you make important investment
decisions.
1) Wiesenberger, 2002.
Performance described is for the period 1/1/1980 to 4/30/2002. Stocks are
represented by the S&P 500 Composite index (total return), which is
generally considered representative of the U.S. stock market. The performance of
an index is not indicative of the performance of any particular investment.
Individuals cannot invest directly in an index. Past performance is no guarantee
of future results. Investments offering the potential for higher rates of return
also involve higher risk.
2) Performance described is for the period 1/1/1980 to 4/30/2002. Treasury bills
are backed by the full faith and credit of the U.S. government as to the timely
payment of principal and interest. The principal value will fluctuate with
changes in market conditions and, if T-bills are not held to maturity, they may
be worth more or less than their original value.
3) Journal of Financial Planning, April 2002
©
2002 Emerald Publications
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