ValueWalk: Stock Investing Risk Is Variable, Not Constant
Investors tend to think of the stock market as having some risk, at least over the short term. But investors also know that it’s the asset class that produces the best returns over time.
However, to average those returns over time, there’s a lot of variability. Some years see massive returns for stocks. Other years see declines. And just as prices can fluctuate wildly, so too can market risk.
Buy and hold investors acquire stocks – shares of companies really – with the long term in mind. It’s somewhat based on the view that companies will improve their performance over time.
But investor expectations can also play a role in how asset prices change. That can either boost or depress a potential investment, which impacts its future returns.
Investments are less risky when market participants are generally depressed. And they can be riskier when investors throw caution to the wind and are willing to pay a premium for companies with little more than a story behind them.
This throws the concept of the efficient market theory on its head. Markets can’t always price everything in perfectly. If they did, we wouldn’t have extreme bargains – or get extremely overpriced stocks at other times.
Overall, market valuation will always have some degree of subjective views weighing on prices. Recognizing when markets are being irrational and offering better bargains can make it less risky to be an investor.