Why Stocks Aren't That Scary

By Stephen D. Simpson, CFA | April 29, 2010 AAA
Why Stocks Aren't That Scary

Reading the news these days, it almost seems like there is something a little wrong with you if you are not afraid of the stock market. We have seen two major stock market declines in less than 10 years. On top of all that is the ever-present fear of losing money.
Still, potential investors should think a little more about the real risks in the stock market. Stocks are not actually that scary, and if people keep a few points in mind, they can successfully navigate the real hazards and be at ease with investing in stocks. (If the unpleasant emotions in When Fear And Greed Take Over are allowed to influence your decision-making, they may cost you dearly.)

IN PICTURES: Learn To Invest In 10 Steps

You Have Enough Money
There is absolutely no rule that says you have to be able to buy 100 shares of IBM to invest; almost any broker will handle an order for 20 or 30 shares, if that is what you would like to buy. Most brokerages have minimum amounts to open an account, but those minimums can be waived in some cases, or there are businesses that cater to investors wishing to put smaller sums of money to work.

If you have $30,000 set aside as a down payment and you expect to buy a house in six months, you do not want to have that money in the stock market. But if we are talking about saving for a retirement that is many years away, even $1,000 or $2,000 is enough to begin investing in stocks. (Your pals may like your returns, but it isn't wise for you to manage their money. Find out why in Why You Shouldn't Manage Friends' Money.)

You Do Not Have to Beat the Market
Some people are scared off from investing in stocks because of the pressure of beating the market. Well, who says you have to beat the market? If the market is up 10% and your portfolio is up 9%, you have not failed. People's risk thresholds are all different, and a conservative portfolio that produces 8% returns may actually be a "better" choice than a portfolio with the same risk as the market that produces 10% returns.

If you find that you must benchmark your performance against the market, remember two things. First, the majority of professional investors do not beat the market. Second, make sure you compare yourself to the right market. If you own a portfolio of large company stocks like General Electric or Verizon, you should not compare your returns to those of the Nasdaq index. As long as you are meeting your goals, what the market is doing is largely irrelevant. (Forget the latest craze - you're more likely to succeed with a buy-and-hold strategy. Learn more in Long-Term Investing: Hot Or Not?)

You Do Not Have to Go it Alone
The amount of resources available to the individual investor is really quite amazing. There are many websites and books dedicated to helping investors educate themselves, whether they are starting from the very beginning or simply looking to learn more about a specific company or industry.

There are also good brokers, financial planners and investment advisors out there to help you become more comfortable with the markets, and investing in general. (If you're a rookie investor, your first big investment decision should be an informed one. Find out more in Picking Your First Broker.)

Stocks Naturally Rise
Fear of loss is one of the strongest and most motivating fears that we can have, and that is not helped by seeing the occasional hiccups and skids in the stock market.

Nervous investors can take some comfort in the fact that there is a natural buoyancy to the stock market, meaning that, over time, stock prices tend to rise. Remember that stocks represent ownership in a real company, and if a real company is properly run, it will grow. That growth ultimately makes the business more valuable and the shares of the company will rise to reflect that.

Inflation is the Bigger Risk
One of the scariest things that most people never think about is the destructive power of inflation. Inflation is a treadmill that is always running - if you are not walking forward, you risk getting thrown off the machine. What that means in financial terms is that if you are not earning returns above the rate of inflation, you actually have less money with each passing day.

Stocks are one of the very few options available to regular people to stay ahead of inflation. There are arguments about the "true" rate of inflation, but most economists will agree that inflation has averaged somewhere around 3-4% a year for the last century, with some periods of unusually high inflation. While there are likewise arguments about the true rate of return of the stock market, there is a consensus that it has been somewhere around 8-10%. Even if you want to assume that future inflation will be higher and future stock returns will be lower, there is still a positive spread there - and that lovely little gap is how investing in stocks can protect your savings from inflation.

Compare that to money market yields of about 0.8%, one-year CD returns of 1.2%, and 10-year Treasury yields of 3.8%, and you can see why stocks are considered a better option. If you buy a stock, you could lose money. If you buy a CD, you will lose money when you consider the influence of inflation. (Inflation is less dramatic than a crash, but it can be more devastating to your portfolio. Find out more in Coping With Inflation Risk.)

Being Poor is Scarier
Putting your hard-earned money into the market can be scary, but there is something that is even scarier - working hard for your entire life and ending up with too little to enjoy retirement. Most people do not have the luxury of making so much extra income that they can simply stash it away in safe money market accounts and enjoy a long and comfortable retirements. For the vast majority of us, getting from "here" to "there" with our retirement plans will require owning stocks, either directly in investment accounts or somewhat more indirectly through company-issued options or mutual funds in 401(k) plans.

Luckily, the stock market is not nearly as scary as it seems from the outside. With some patience and hard work, even the most inexperienced individual can learn enough to evaluate investment opportunities, put money into the market and earn successful returns on those investments.

Find out what else is making news this week Water Cooler Finance: Everything Old Is News Again.

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