---
title: "Understanding Investment Risk"
description: "Stock investing has risks; how to understand, plan for, and manage risk to protect yourself and build wealth--and the hidden risk all investors must know."
canonical_url: https://trendshare.org/how-to-invest/understanding-investment-risk
markdown_url: https://trendshare.org/ai/understanding-investment-risk.md
published: 2013-07-18
last_updated: 2017-06-17
content_license: https://trendshare.org/about/disclaimer
---
# Understanding Investment Risk

Source: https://trendshare.org/how-to-invest/understanding-investment-risk
Updated: 2017-06-17
The time-worn image of a cautious saver stuffing handfuls of dollar bills
under a mattress is pervasive for a reason. You can even take that further to
your odd uncle who [buries gold bars in the back yard](https://trendshare.org/how-to-invest/should-you-invest-in-gold-or-silver). Maybe that's not you, but you can understand the
temptation. You work so hard for your money that the thought of losing it all
makes you sick. Where can you invest your money to give it a chance to grow?
chance to grow? How can you protect yourself from losing value?

These questions keep some people out of stocks. No investment is 100% safe.
Every investment has risks. Some are obvious but others are subtle. Can you
manage them appropriately? Yes!

## What are the Top Investment Risks?

Investment risks fall into three categories: losing all of your principal,
making smaller returns than you wanted, and missing better opportunities.  The
first is the most scary, but the last is the most consequential. If you're in
the market for decades, the magic of compound interest is your strongest ally.
Sub-optimal return will cut down your wealth over time. Dramatically.

*Losing all of your principal* is the most obvious stock risk. You
could buy shares of a Canadian bed and breakfast in Caribou country—and,
one summer season of no visitors later, everything is gone. You're left as the
shamed owner of worthless stock certificates. The thousand dollars you wanted
to turn into ten has become zero.

Protect yourself from principal loss by researching and buying good
companies ([good companies have reliable and predictable earnings](https://trendshare.org/how-to-invest/earnings-matter-most)). The unexpected may still happen. Perhaps a natural
disaster will disrupt shipping or manufacturing or a new product or service
just won't take off. Otherwise, investors just might get antsy about the
company and devalue it below its true value. Yet good companies can weather
these storms. This can be a great opportunity to [buy more of a good stock at a great price](https://trendshare.org/how-to-invest/when-stocks-go-on-sale).

*Earning smaller returns than anticipated* is a risk often realized
from getting your research wrong (and, often, ignoring a [margin of safety](https://trendshare.org/how-to-invest/what-is-a-margin-of-safety)). Maybe you've
overlooked something. Perhaps you made a silly math error. You may have
predicted better success for [a new product line that, in retrospect, no one ever would have bought](https://www.aol.com/article/2016/05/25/top-25-biggest-product-flops-of-all-time/21383586/). In
this case, you won't make as much profit as you wanted—you might lose
money—but you're unlikely to lose it all.

The third risk is more subtle.

## Balance Risk and Opportunity in the Market

*Missing a great opportunity* is the final and most subtle risk of
investing, and it's deeply personal.

Your ability to sleep soundly at night helps determine how you allocate your
investment dollars. For example, if you have *no* tolerance for risk,
you might buy [US Treasuries as investments](https://www.treasurydirect.gov/indiv/products/prod_tbills_glance.htm). They have a terrible return, but unless the US
decides to stop paying its bills altogether, you'll always get what you paid
out of them. (Don't mistake the political debates over [the deficit spending of the US Federal Government](https://outspeaking.com/words-of-politics/what-is-deficit-spending.html) with serious attempts not to
pay back Treasuries and other debt instruments of the US government. If the
latter ever occurs, you will have bigger problems than the rate of return of
your investment.)

You probably can tolerate more risk than Treasuries and their
sub-one-percent returns. An average six to eight percent return over multiple
year periods is often available in a simple [index fund](https://trendshare.org/how-to-invest/what-is-an-index-fund). The risks are higher, as the value
of the fund may go down and stay down for a couple of years, but the reward
over almost any time period you can imagine balances out the risk—so much
that it's almost not even a question.

You can even cushion the risk of an underperforming investment by factoring
in a margin of safety to account for missing information or other unknowable
risks. You need to do a little math to calculate the [present value](https://trendshare.org/how-to-invest/what-is-present-value) of the stock to calculate the
maximum price you want to pay based on the size and stability of the company.
If that number is plausible, you may have found a great deal.

## The Opportunity Cost of Not Investing

Inaction keeps many potential investors from good opportunities. If you find
a great deal—a [pearl of great price](https://www.biblegateway.com/passage/?search=Matthew+13%3A45-46&version=NASB) situation—you want to be able to take advantage of it
without hurting your current financial situation. If all of your money is tied
up in other investments, you might have to sell them at losses or risk losing
out on the amazing investment.

You can control this! If you have a coherent long term plan and you're
following it well, it doesn't matter if you miss some opportunities as long as
you take advantage of the *good* and *realistic* opportunities
you truly have. You don't have to make the maximum return possible on every
stock you investigate to build wealth. You only have to make good choices on
the stocks you actually buy.

With that said, once you've built up some spare money from dividends or
profits you've taken, consider whether you should hold back some free cash
until the next good opportunity makes itself known. If nothing's a bargain
right now, you don't have to have your money invested. You can afford to be
patient.

## The Hidden Risk All Investors Should Know

*Impatience* is the most subtle risk of investing is impatience.
Building wealth takes time and care. You won't double your money overnight, not
in any reliable or repeatable way. Don't confuse action for effect. To become a
millionaire in a week, win the lottery. To build real wealth through investing,
spend years cultivating good habits and letting compound interest work for
you.

By all means, keep some free cash set aside for that once in a lifetime
opportunity you'll always regret passing up, but let yourself be patient. You
don't have to make money on *every* possible bargain, as long as the
bargains you find are good ones. It takes time to find great stocks to buy and
to figure out their stories. It takes time for the market to find the right
price for a stock.

Investing doesn't have to be stressful. It can even be enjoyable, if you set
realistic goals based on your appetite for risk and make thoughtful
choices.