Overcoming the Fear of Investing: What Rational Steps Can You Take?

Investing can feel daunting, especially when the risks seem high. For many, fear of losing money keeps them from exploring opportunities in the stock market. But understanding the types of risks, and how to mitigate them, can help shift your perspective and empower you to make informed investment decisions.

Understanding Investment Risk

When people think of investing, they often focus on the worst-case scenarios, like a company going bankrupt and wiping out their savings. This is called single-asset risk. the risk associated with investing in just one company or asset. However, this can be mitigated by diversification. By investing in multiple companies, industries, and regions, the chances of a single event impacting your entire portfolio become negligible.

The real risk you face with a well-diversified portfolio is market risk. Market risk refers to the natural ups and downs of the overall market, something that affects all companies at the same time. Although market declines can feel alarming, they are a normal part of the investment cycle. Let’s look at some historical data:

• On average, the stock market declines by about 5% once a year.
• Every 2-3 years, the market typically sees a 10% drop.
• Market declines of 20% occur roughly every 3-6 years.
• Every 10-20 years, it’s normal to experience a significant drop of 30-50%.

Why Accept Market Risk?

While these numbers may seem unsettling, it’s important to understand that market risk is also what makes long-term investing profitable. Over the past century, the stock market has returned an average of 10% per year, despite these fluctuations. Investors who stay the course and don’t panic during downturns are often rewarded with strong long-term returns.

The key takeaway: volatility and returns are connected. By accepting short-term fluctuations, you position yourself to earn long-term rewards.

Long-Term Investing: Mitigating Risk with a Diversified Portfolio

To mitigate market risk, you can use a combination of strategies, including diversification across asset classes. Here’s a simple example of how to structure a balanced portfolio:

Portfolio Example:

• 60% Equities and Property: These are diversified across thousands of companies in different industries and regions.
• 40% Bonds and Term Deposits: These provide stability and liquidity, especially during periods of market decline.

This allocation allows for growth through stocks while ensuring some funds are protected in bonds during times of volatility.

Dealing with Market Declines

It’s normal to worry about what happens when the market falls. Imagine you are approaching retirement and the market suddenly drops by 20%. How can you avoid selling stocks at a loss?

Here’s where the 40% allocation to bonds helps. Rather than selling stocks when they are down, you would draw from your bonds to cover your expenses. This gives your stocks time to recover, preserving their long-term growth potential. Historically, even large market drops have fully recovered within 5-7 years.

By having bonds available, you give your portfolio breathing room, ensuring that a temporary decline doesn’t derail your long-term financial goals.

How Much Can You Really Earn?

To visualise the potential long-term gains from investing, consider this calculation. Let’s assume two different investors: one who decides to stay conservative with low-risk savings, and another who takes on market risk by investing in a diversified portfolio of stocks and bonds.

Scenario 1: Conservative Savings

• Investment: $10,000 in a savings account earning 4% per year
• Annual Contribution: $5,000
• Future Value after 20 years: $170,740

Scenario 2: Diversified Investment Portfolio

• Investment: $10,000 in a portfolio with an average return of 8% per year
• Annual Contribution: $5,000
• Future Value after 20 years: $247,115

In this case, the diversified investor ends up with almost $76,375 more than the conservative saver. Despite short-term volatility, the power of compounding at a higher return rate leads to significantly higher long-term growth.

How Much Do I Need to Start Investing?

One common misconception is that you need a large amount of money to start investing. However, that’s not true. In fact, you can start with as little as $500 and build your portfolio over time through regular contributions. Many investors choose to set up a regular investment plan, allowing them to take advantage of dollar-cost averaging  the practice of buying more shares when prices are low and fewer shares when prices are high. This can smooth out your investment costs over time.

A Plan to Alleviate Fears: Putting it All Together

Here’s a simplified plan to help you start investing confidently:

• Diversify: Avoid putting all your eggs in one basket. Spread your investments across sectors and regions.
• Balance: A 60/40 portfolio (60% stocks, 40% bonds) can help you manage risk.
• Stay the Course: Expect market declines but trust in the long-term growth potential.
• Invest Regularly: Start with what you can afford and build your portfolio over time.
• Focus on the Long Term: Aim to keep your money invested for at least 5-7 years to ride out volatility.

The fear of investing often stems from misunderstanding risk. By diversifying your portfolio and preparing for market fluctuations, you can manage those risks and make informed, strategic decisions. The long-term rewards of staying invested and not panicking during downturns are clear in both historical data and projections.

Including both growth and safety in your portfolio not only provides peace of mind but also maximises the potential for wealth accumulation over time. This balanced approach, alongside regular reviews and adjustments, will help you stay on track toward your financial goals.

Navigating financial decisions can be complex, and my focus is on building long-term relationships built on trust and understanding to help achieve the best outcomes for you.

Whether you have questions, need guidance, or just want to share your thoughts, please feel free to reach out. I genuinely value the opportunity to work together and assist you in reaching your financial goals.

General advice disclaimer.

The information in this graphic is of a general nature and does not take into account your own financial objectives, circumstances or needs. You should consider your own personal situation and requirements before making a decision. If you have concerns or questions, please contact me/us.