MONEY OBEDIENCE

Market Risk and Physical Exercise

When many people think about financial risk, they think of things like the risk of investing and then losing in the stock market. That risk is called “market risk”, since you expose your savings to the whims of the stock market.

Losing money is a scary thing for anybody. Who wants to see his or her hard-earned money vanish for no apparent good reason? I sure don’t. So, most people go out of their way to avoid losing money, and they stay away from the stock market. But staying out of the market is not necessarily safer. How so?

If you avoid the risk of the stock market by not investing at all, you are assuming two other major risks of which you may not be aware. One such risk is “purchasing power risk,” or the risk that your savings could lose hidden value over time by not keeping up with inflation. The other risk is that you might not reach your financial goals by not making your dollars earn as much as they can. (More on these two risks in another post.)

The thing to remember is that financial risks sometimes are also paired with financial opportunities. The downside is that risks and opportunities may not always appear in equal probabilities. There can be good outcomes to risk taking behavior — for example, stock prices could go up instead and earn you gains. However, many people avoid taking the chance, because to most it feels a lot worse to lose $1000 than to make $1000.

To illustrate market risk let me draw one parallel that might be easier to grasp. Let’s think for a minute about health risk. One way to avoid risking your health is regular exercise. Exercise keeps the heart and lungs in good shape, it tones your muscles, it improves your immune system, and it improves your mood. But the downside of exercise is an exercise injury. If you do any type of physical exercise, you run the risk of an exercise injury. A machine can malfunction in the gym, you may twist your ankle really badly while walking, you could fall off your bike; all kinds of things can happen.

Say you decide that you are so scared of an exercise injury that you stay away from exercising entirely. You become a couch potato! Sure, you’ll never get injured doing some “crazy” sport. But your body will deteriorate over time when you don’t exercise enough.

Avoiding exercise altogether in order to avoid the risk of injury is not a good solution. You obviously have to balance the negative risks of exercising with the benefits of exercising. You also have to think about the risk of not exercising and then you determine how much exercise you want to do. And, of course, everyone’s different. Some prefer yoga or tai chi, and others want to do something more risky. Some prefer marathons or triathlons, and others think such activities are too much for them.

Market risk works in a similar way. You got to balance the negative risks of the market (i.e. losing money) with the benefits (i.e. making money), and also determine how much risk you want to take. It’s not good to force your money to become a couch potato by staying out of the market, but you don’t want to put your money through a triathlon if, first, you don’t have enough time to let it “train” so that you see the long term benefits. (Just like you need to give your body time to get ready for the race, you need to give your money time to get to the finish line of making profit.) If you don’t have a lot of time before your money has to perform – the finish line is coming up fast – then don’t risk “injuring” your money out in the stock market. If you do have the long run in your favor, then such investment in the market isn’t a bad idea because over many years market returns average out pretty well between good and bad years. If you have time on your side, think about investing.

Be sure you think about what balance of risk makes you comfortable and don’t avoid it altogether just to play it “safe.”

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