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Lesson
3: Risk
Taking
a closer look at the annual returns charts for US and UK
equities over the past century in Lesson 2, one notices
that whilst over the long term one sees steady returns
in the markets, some individual years see substantial
declines. These declines are plainly evident in, for
example, 1929 and 1987.
This
gives us a clue as to the subject of this lesson. The
risk of individual Asset Classes.
Most
of us, even those new to Investing, are familiar to the
Risk/Return concept. It be be further spelled out as
‘No Risk-No Return’. Leaving our money in a Bank
account is about as safe as it gets, in terms of
protecting the capital amount. However, the spending
power of the Investment will erode with time, as the
ever present effect of Inflation bites.
Whereas
we have already proven that Investing in Stocks will
definitely give us returns substantially above inflation
in the long term. However, with these higher returns
comes the potential risk of large losses in capital
value due to market declines.The
chart below shows the Annual Real returns of the
Standard and Poors 500 Composite Index from 1872 to
2000. Being a chart of Real returns, this chart has the
effect of CPI factored out.
S&P 500
Composite Total Returns Index 1872 to 2000
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