What is risk? Is there risk investing in stocks? Risk is measured in many different ways. Beta, or standard deviation, is the most popular measure of risk in the financial industry. But does beta really measure risk? No, beta measures volatility, or the up and down movement, of a stock’s price. At unpredictable times there can be high price volatility, resulting in market fluctuations. A speculator attempts to profit by anticipating these changes. An investor, on the other hand, is more concerned with the growth over time of the businesses he is invested in and should expect prices to fluctuate.
“Investment is an activity of forecasting the yield on assets (businesses) over the life of the assets; .... speculation is the activity of forecasting the psychology of the market.”
John Maynard Keynes
“But stocks are riskier than bonds or GICs!”. Well, if losing money (rather than price volatility) is how we define risk, and money is represented by purchasing power, then stocks are ultimately less risky than GICs. The real risk isn’t losing your money, but losing or not growing the purchasing power of your money. If this doesn’t seem significant, think back twenty or more years to what you paid for your first house, or car, or postage stamp. If it costs twice as much to buy something twenty years from now, and your money, ex inflation and taxes, hasn’t grown, then you have actually lost money (purchasing power) in the safe, guaranteed investment. In the short term GIC’s are absolutely safe, but over a long period of time they become risky compared to equities, which historically have done much better.
Consider this - as of June 30, 1999:
$1 invested in T-Bills in 1950 is now worth ~ $22
$1 invested in long term Bonds in 1950 is now worth ~ $36
$1 invested in 5 year GICs in 1950 is now worth ~ $39
$1 invested in the TSE 300 in 1950 is now worth ~ $170
$1 invested in the US stock market in 1950 is now worth ~ $650
Source: ‘99 Andex Chart for Canadian Investors