This post will be focused on understanding the risks associated with investing in the stock market.
Before you entrust your investments into any field, acquaint yourself with the dangers which may befall your principal.
-Arkad, The Richest Man in Babylon, p34.
What losses do we encounter when investing in stocks?
Although this is not an exhaustive list, it should acquaint us with the risks associated with investing:
1. Principal losses
Principal (not principle) is the term used to identify the initial money used in an investment. The investment industry seems to leave this concept on the side when they attempt to get us the lay investor to place money into their investment accounts. Stock investing has some of the least protection to the original principal. Dangers to your original investment include the possibility that the company you invest with is forced into bankruptcy. This is no small matter for the investor because if a bankrupt company’s assets are liquidated, the proceeds are first used to pay any debt obligations the company had.
Complete principal loss is fortunately not too common in the stock market but it does happen, some examples that come to mind are Enron, WorldCom, Lehman Brothers, General Motors and recently Hanjin Shipping. Unfortunately, some companies don’t declare bankruptcy but still lose a lot of their value for their investors and this can be more common. Companies that find themselves in this later category should make any investor leary of stock investing: Nokia which dropped from a high on 04/01/2000 of $50.38 to $4.45 on 11/01/2016 and Xerox heading from a high of $59.06 01/01/1999 (party likes its 1999 anyone?) to $9.78 on November 1st. This information is not shared to scare us away from investing in the market or even investing in individual stocks-it is shared to illustrate the possibility and potential scope of stock losses.
2. Opportunity losses
The other side of potential losses is the main selling point of the investment community: opportunity loss. The potential to miss out on the rise of the stock market as it has proceeded to increase in value for the majority of our lives is very alluring. For example, the Dow Jones Industrial Average has increased approximately three times its value on 12/1/1996-this includes the losses incurred in the financial crisis and the dot com bubble. This is even more pronounced when we consider the price of Google since its initial public offering. The company opened at $50.05 on 8/1/2004 and on 11/1/2016 it closed at $775.97. This would mean that investing $10,000 in August with Google would be worth over $155,000 today. A quick analysis of Netflix, Facebook, and Amazon would garner similar results. No wonder this is such a great sales technique for the would be investor.
Other opportunities should also be considered. Investing your hard earned money with the stock market may prevent you from purchasing other sound investments like real estate or owning a business. The money placed in the market should create returns that are superior to these and other investments.
3. Time losses
The last consideration of potential loss in the stock market is time loss. Investing in the market when principal is lost can cause us to worry often about what the future holds. This may be the most painful loss to consider because it could include lost time with family and friends and a loss of health due to the additional stress it can cause. In my opinion, this is one loss that can make investing not worth it.
Although this list is not exhaustive, it should help us understand the risks that we face when considering investing in the stock market. What other risks might an investor need to consider in your opinion? I appreciate your comments.