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Financial Planning -> Stocks, Bonds etc.

Risk - as it Relates to Investing

We aren't experts at risk, but this is how we see things.  The main types of risk are political risk, the risk of volatility, and risk related to the quality of investments.

There is political risk in all countries, because as governments change, their policies change.  This can affect the price of investments quite dramatically, especially if the government is a socialist government, or a non-democratic government.

Stock markets are often volatile due to greed and fear.  Greed can drive stocks to unrealistic highs, and fear can drive them to unrealistic lows.

Interest rates can also cause volatility in stocks and bonds.

Another risk is the quality of the company behind the stocks.  Developed countries have securities laws which require companies to provide audited financial reports annually.  These reports are usually reliable.  When investing in developing countries, the reports may not always be reliable.

When you are buying bonds, their rate of return is related to their risk.  There are bond rating agencies that rate the bonds from AAA to junk.  As the quality of the bond decreases, the rate of return increases.  The main risk with bonds is that their returns are not as good as stocks, and you may end up outliving your money.  This is much less likely with stocks or ETFs.

As stocks go up you don't usually hear very much about it, but when they go down, it is often on the front page of the newspaper.  This is because stocks usually slowly rise, but occasionally they go down very quickly.  Every day there is a financial crisis happening somewhere in the world.  If you just pay attention to all the bad news, you would never invest in stocks.  Some of the financial crises include:

bullet 1965 - The Dow Jones Industrial Average (30 large US stocks) closed at 969.3.  It did not again reach and stay over this price permanently until 1982.  For 17 years there was no return.
bullet In this same 17 year period, the S&P 500 (500 large US stocks) increased from 40 to 142.
bullet 1980 - In January, Gold hit high of $850 US per ounce.
bullet 1980s - Savings & loan crisis in the US.  Over 1,000 savings & loan institutions failed.
bullet 1987 - North American stock markets crashed.
bullet 1989 - Japan's Nikkei 225 index hit a high of 38,915, and by 2002 it had fallen to 8,303.
bullet 1994 - Mexico had a major economic crisis.
bullet 1998 - Russia went bankrupt (defaulted on its bonds).
bullet 1998 - Emerging Markets fell 22%.
bullet 1998 - Hedge fund Long Term Capital Management went bankrupt.  The Board of Directors included 2 Nobel Prize winners for economics.
bullet 1999 - Brazil economic crisis
bullet 2000 - Emerging Markets fell 32%
bullet 2000 - The tech bubble burst.
bullet From 2000 to 2002:
bullet the Nikkei (in yen) was down 69%
bullet the S&P 500 (in US$) was down 43%
bullet the TSX (in Cdn$) was down 22%
bullet European markets (in US$) were down 51%
bullet 2001 - 9/11.
bullet 2002 - Argentina went bankrupt (defaulted on its bonds).
bullet 2008/09 US financial crisis:
bullet Dow Jones went from over 11,300 in Sep 08 to just over 6,600 in Mar 09
bullet TSX went from over 12,900 in Sep 08 to 7,591 in Mar 09
bullet 2011 - In August, Gold hit a high of $1,916 US per ounce.  This is an average return of 2.6% per year from the January 1980 high of $850.
bullet 2011 Portugal, Iceland, Ireland, Italy, Greece, Spain (PIGS) financial crisis.

The following list shows how countries and economic sectors are usually rated, from low risk to high risk.  The positions in the list will usually change as countries either falter or prosper, and as economic sectors are re-evaluated by analysts.


     Risk ratings of stocks in various countries or economic sectors     

Zimbabwe

Undeveloped markets

China

Russia

Indonesia

India

Ukraine

Poland

South Africa

Brazil

Mexico

Singapore

Emerging markets ( VWO)

Sweden

Italy

Canada

Japan

Germany

United Kingdom

Pacific Region (VPL)

United States (SPY)

Europe (VGK)

High Risk

Sectors

 

Energy

Materials (Resources)

Technology

Industrials

Health care

Consumer discretionary

Financials

Telecommunications

Consumer staples

Utilities

Long bonds

Medium bonds

Short bonds

Cash

 

Low Risk

The risk of an ETF (VGK, VPL or VWO) is less than the risk of the individual countries it represents.  See our article on recommended stocks (ETFs) for inside or outside of your RRSPs.

How to lessen risk:

bullet do your own research, or get professional advice to help pick stocks.  There are hundreds of different organizations that rate and make recommendations about stocks.
bullet have your investments diversified across many countries and industries
bullet buy good quality stocks or exchange traded funds (ETFs)
bullet hold your investments for long periods of time
bullet when buying bonds, buy investment grade (BBB or higher) bonds

Despite all the financial crises that occur, you can see by our article on historic returns on stock markets and other investments that by buying quality investments and holding them for a long time, you can make a good return on your investments.

See also the article on currency risk.

Tip:  Buy quality investments and hold them for a long time.

 

Revised: April 10, 2016

 

 

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