Chart: What Is Risk?
I love this chart because it provides such a clear relationship between risk and return. You want more risk (say 100% stocks), well you better be prepared for great years (54.2% was the best year from 1926-2013) and be able to stomach big down years (down 43.1%) without hopping out. It also demonstrates the most important decision that an investor will make is their asset allocation or their split between stocks and bonds. Note also that stocks here doesn’t refer to picking individual stocks but rather investing in low-cost, diversified index funds and the same for bonds.
Questions for students:
- Your friend asks you “What mix of stocks and bonds will provide the highest return?” What is your answer?
- Another friends, says “I hear that you should always invest in bonds since you can’t lose money.” Is that true?
- What trend do you in terms of the range of best to worst years as you reduce the amount of stocks that you own?
- Pinpoint on the chart where you think you will be when you are ready to start investing. Why did you pick that spot?
- Which asset class, stocks or bonds, had the highest average return between 1926-2013? How much higher was its average return?