One of the most common refrains you'll hear from those reluctant to invest in the ASX stock market is that investing in shares is 'too risky'.
This is understandable. In popular culture, the stock market has often been described as akin to a giant casino. An exclusive playground where the rich make and lose their fortunes. What was the last movie you saw that portrayed investing in shares as something everyone can do to build wealth over long periods of time?
Yet that's exactly what the share market is. Sure, the rich and famous can use it to make or break their fortunes. But anyone who is successful at investing in shares usually does so by buying quality businesses and holding them for long periods of time. That's how Warren Buffett has done it anyway.
But there's no getting around the fact that investing in ASX shares is inherently risky. There's always a chance that a company you have a stake in hits a snag, a wall or goes bankrupt completely. Anyone who pretends otherwise is misleading you.
There's a reason why financially-minded people talk about the tradeoff between risk and reward. As a general rule, the more potential returns an asset has, the riskier investing in it will be. That's why ASX shares tend to offer higher potential returns than bonds. Bonds, in turn, usually offer higher returns again than cash investments like term deposits.
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Why we all need to risk a little with our ASX shares
Of course, some investors like Warren Buffett argue that investing in shares, ASX or otherwise, can be very low risk. But that's a conversation for another day.
Howard Marks is a successful hedge fund manager and one of the most famous people in the world of investing. His regular 'memos' are essential reading for many aspiring investors.
In one of Marks' most recent memos, he discusses this risk tradeoff, and how it is actually riskier to accept a lower level of risk in your investments:
Because the future is inherently uncertain, we usually have to choose between (a) avoiding risk and having little or no return, (b) taking a modest risk and settling for a commensurately modest return, or (c) taking on a high degree of uncertainty in pursuit of substantial gain but accepting the possibility of substantial permanent loss…
Most investors are capable of accomplishing 'a' and most of 'b'… [but] the risk inherent in not taking enough risk is very real. Individual investors who eschew risk may end up with a return that is insufficient to support their cost of living.
Right now, most Australians are feeling a cost-of-living pinch. Interest rates remain at a decade-high. And sticky inflation is making it difficult for most workers to enjoy wage rises in real terms.
That means 'risky' investments like ASX shares are one of the few places we can put our money to work if we aspire to get a real return on our money. If you opt for a 'safe' investment like a term deposit today, chances are that inflation and taxes will erode most, if not all, of our above-inflation gains.
That's why Marks argues that it's actually riskier to not risk your money in wealth-creating assets like shares.
