Buying shares is seen in some circles as a ‘get rich quick’ scheme. In newspapers and the wider media, you will often hear about the share prices of certain companies as rising ‘by 74% in a year’ or other significant increase.
Hearing about profits of this magnitude can be very exciting, and really inspire people to abandon ‘boring’ savings accounts at their bank, and jump into the stock market.
But hold up – a stock market is also a place where stories circulate about traders losing everything and contemplating jumping off their stockbroker office building. So… slow your breathing, let the adrenaline pass, and let us think carefully about the risks of buying shares so that you have both sides of the debate in mind.
Are shares risky?
‘Is buying shares risky?’ is a question I often hear as a financial blogger. It’s a very good question and isn’t quite as simple as it sounds.
To some, the answer is a resounding ‘yes, shares are risky’. But a more useful answer is ‘it depends’.
What does it depend on exactly? Well, time. Time is the ultimate de-risking tool that investors use to tolerate the ups and downs of the stock market.
Why is time so important?
The reason why time heals all is that stock market crashes are inherently temporary affairs. They’re traumatic, they happen sometimes over time, but eventually, they pass.
Because the modern stock market effectively represents the corporate world, the only scenario in which the stock market does not recover, is a world in which society as a whole does not recover. In such a doomsday scenario – nobody wins, we’ll probably be fighting off the zombie hordes or using our furniture to cook our pets. It’s a real possibility that this ‘could’ happen in our lifetime, but it’s not worthwhile to really factor this into our financial planning, because this is such an extreme scenario that you pretty much can’t prepare for it without going to extreme lengths.
In every other scenario, the stock market will eventually recover because corporations will always bounce back after economic setbacks, no matter how hard.
Do you recall the financial crisis of 2007- 2010? At the time it was referred to as one of the greatest financial disasters in the last 100 years. And yet within 5 years, diversified shareholders were back in profits once again.
I hope this reinforces the picture that shares are risky if you hold them for short periods because they are vulnerable to shock drops in the market, which will cause a paper loss for anyone holding shares and a permanent loss for anyone who sells at the bottom of the market.
However, the stock market has always recovered and then exceeded the value of the market pre-crash, eventually. This is why long term investors don’t fear the stock market in the same way as members of the public.
Take a look at pension funds for another example of a fearless investor with plenty of time on their hands. Pension funds can afford to invest over extremely long term periods, on the basis that their members usually are restricted from even accessing their funds until the end of their career.
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This means that pensions know that they have the ability to ‘wait’ when a crisis comes along. They can sell bonds and other more liquid investments to meet pensioner requirements, and continue to hold shares during a slump to avoid taking real losses by selling.
In this way, we see that pension funds – arguably some of the most prudent financial organizations in existence, still buy shares. What does this tell you about the risk of shares?