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Investing Mistake: Too Much Focus on Risk Aversion

Jonathan Swanburg
By: Jonathan Swanburg
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As a group, millennials fear stocks. They witnessed the market collapse in 2008 and believe something even bigger and more devastating could be just around the corner. This anxiety is one of the main reason they tend to keep the large cash balances, over-invest in bonds, and favor safety to volatility. However, by focusing on the near-term risks, young investors miss out on the long-term benefits of investing in the stock market.

The argument for taking a long-term, diversified, approach to stock investing requires historical context. Since World War II there have been thirteen market declines of 30% or more. Some of these have been fast and extreme. For example, on Black Monday, October 19, 1987, the Dow Jones Industrial Average fell by 508 points to 1,738.74. This represented a drop of 22.61% in a single day. Given the number of large drops in the past, it is safe to assume another 30%+ drop will occur in the future. In fact, when investing in a stock index, it is fair to assume for planning purposes that it will drop by 30% tomorrow. However, it is also important to remember that a 30% decline in price is not a bad thing as long as you are diversified and stay the course. Ups and downs are simply part of the investing process and attempts to avoid the downsides will mean missing out on much of the upside.

To give you an example, imagine a 30-year old investor that put his life savings of $50,000 in to a hypothetical Dow Jones Industrial Average index fund the day before the crash. At the time, I’m sure he would have felt sickened by the decline in market value. However, if he shut his eyes and held on, his investment decision was vindicated. Today the market is above 20,000, he is 60-years old and that investment made on the worst day of the decade, is worth approximately $500,000 without having added to the account or reinvested the dividends.

Holding on for thirty years wouldn’t have been easy. During that time there were wars, scandals, pandemics, natural disasters and a litany of other scary things but somehow the market proceeded higher. That same future holds true today. Despite an unknown number of terrible things that will inevitably occur over the next thirty years, there will also be a larger number of great things that propel the market higher. If the Dow Jones Industrial Average averages growth of 7.2% per year, in 10 years the market will reach 40,000, in 20 years it will reach 80,000 and in 30 years it will reach 160,000. It won’t be straight line growth and it won’t always be easy to stay the course but exposing a long term portfolio to equity risk will be an important part of building wealth over time.

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This article is from the five-part series on the Most Common Investing Mistakes.

Investing does not have to be complicated but far too often, individuals take risks they don’t understand, trying to outperform a benchmark that has no relevance to their financial goals. This series is focused on simple things savers can do to improve their long-term performance.