Making money in the stock market through investing is one of the toughest businesses and most people are afraid of the wrong thing when it comes to investing.

The pain of loss is more than the joy of making profits and that’s why investors will remember any stock market loss or market crash so vividly. If you ask anyone what financial risk looks like and many will remember a stock’s share price crashing, a panicked investor watching their investments evaporate, a headline screaming “Market Crash” or “Bloodbath”. 

While investing involves different kinds of risks, there is also another type of risk which many people do not realize and it is quieter and common among non-investors. Let us understand how being too conservative or aggressive will play spoil sport for investors. 

Aggressive investor 

Aggressive investors would like to give more importance to maximum capital appreciation over capital preservation. These investors will invest in high volatile, high growth stocks, emerging sectors, commodities and have a high risk appetite. They can endure substantial short-term market swings in exchange for the potential of higher returns. The inexperienced ones bite more than they can chew. 

Aggressive investors prioritize maximum capital appreciation over income or capital preservation. They allocate heavily into volatile, high-growth assets like equities, emerging sectors or commodities and they have a high risk appetite, so they are fine with enduring substantial short-term market swings in exchange for the potential for higher long-term returns.

Any concentration of risk, high leverage, speculation without any margin of safety net are genuine threats to your financial wellbeing and long-term plans of wealth creation. 

But here’s what those stories have in common: they’re visible. The loss is obvious. You can point to the number that went down. It’s painful, but at least you know it happened.

Conservative investor who played it too safe 

Assume an investor who is extremely conservative and thinks the stock market is a big den for gambling. As a result she has never invested in stock directly or through mutual funds and does not have much knowledge about cryptocurrencies.

The investor was happy parking their money in a savings account or a fixed deposit for the past few years, earning a modest 3–6% interest per year. The investor was feeling safe and the conventional wisdom said it was the right thing to do. 

But the conservative investor did not account for one important economic data that is expected to erode the savings of anyone and that is inflation. 

If inflation is hovering at 6% annually on an average and her savings are earning about 4%, she is effectively losing 2% of her purchasing power every single year. Not in nominal terms but in real terms. The number in her account may keep going up but the returns would not beat inflation which means the purchasing power of the investor is actually falling behind. 

Over a decade or two, this silent erosion is real and the savings that must have funded your retirement or a home or child’s education has quietly shrunk in value and would not meet the required needs. This is the risk no one warns you about because it happens slowly without much noise.

What is the right amount of risk

There is no one size fits all answer for the amount of risk that everyone can take. It varies depending on their financial objective, time horizon, risk appetite, etc. Risk is not inherently good or bad and it is like any tool and the tool must be used judiciously to achieve your financial objectives.

Time horizon

Assume you are in your late 20s and you plan to start investing for your retirement, then being too conservative will not serve the purpose. You can afford to take moderate risk to invest across various asset classes so that you build a reasonable risk to reward portfolio. 

However, if you are in need of money to buy a home in two or three years, then the stock market would not be the right place to invest as it could be volatile and you may not get the required returns in such a  short time and you may not be able to fulfill your financial objectives. In investing, time is an important variable because time plays a vital role in compounding and if the time frame is longer then the investor can afford to ride out the volatilities that may happen in the market.

Difference between volatility and permanent loss

A stock market is a risky place to invest but the rewards are higher. The stock markets can be volatile and may drop 30% during any market downturn or recession and recover in the following months as it happened during the covid pandemic. Over a period of 20 or 30 years, the stock market has only risen. However, keeping money in cash or in simple savings deposits (3% return) can affect your long-term goals because losing 3% of real value every year due to inflation of 6% is a permanent loss and there is no way that lost money can be recovered. 

Diversification to minimize risk

Diversification is an important concept or process which every investor must follow to minimise risks. The markets are uncertain and we do not know which stock or sector or asset class will perform at what time and for how long. Diversifying your investments will not only reduce risks but it will also ensure you are able to capture the upside of that particular asset class. A portfolio diversified across equities, fixed-income securities like bonds, real estate or REITs and cash or cash equivalents is not just to protect from any catastrophic loss but it is also a way to position yourself to grow in different market conditions.

Knowing your risk appetite

Suppose you plan to be a long-term investor to achieve a certain financial objective then it is imperative for you to know your risk tolerance. As an investor knowing your risk tolerance will help you not to make any irrational or erratic investment decisions. 

Most investors overestimate how much risk they can handle until they actually experience a downturn. There is no harm in building a portfolio which is slightly more conservative than the textbook optimum, as long as you are well aware of the trade-off you are making. The worst financial decisions happen when people panic during a correction because they took on more risk than they could emotionally tolerate and end up losing money because they liquidated at a loss. 

Real cost of both extremes

Let us understand the negative effects of being too aggressive or too conservative with the help of an example. 

Imagine two investors aged 35 are starting to invest with Rs 50 lakhs and they are targeting a retirement at the age of 65.

Investor A takes too much risk and invests most of his/her money heavily in speculative assets and suffers a major loss in a downturn. The investor ends up with an average return of just 4% per year due to losses wiped out during market downturns or crashes or the market moving sideways during that period.

Investor B takes too little risk and parks everything in conservative fixed deposits or savings deposits earning around 3-5% nominally.  But with a 6% inflation environment, real return would be -3% to -1%.

Investor C builds a balanced, diversified portfolio which earns an average real return of 6% per year after inflation.

After 30 years:

Investor A: Rs 50L × (1.04)³⁰ = ~₹1.62 crore nominal, but in today’s purchasing power (adjusting for 6% inflation) that’s only ~₹27 lakhs which is less than what they started with.

Investor B: Rs 50L × (1.05)³⁰ = ~₹2.16 crore nominal. Sounds good until you account for 6% inflation. Real value is just ~₹37 lakhs.

Investor C: Earning 6% real return, Rs 50L × (1.06)³⁰ = ~₹2.87 crore in today’s money.

Investor A ends up with roughly ₹1.62 crore in nominal terms, but he/she is still behind on real purchasing power goals. Investor B’s nominal balance looks healthy, but real purchasing power has declined and Investor C has built a corpus of over ₹2.87 crore in real terms.

Conclusion

The biggest risk for anyone in life, including investors, is not taking any risk. It is not always the people taking bets who lose the most. Sometimes, it is the ones who are extremely conservative thinking they are playing it safe for years. This financial habit will quietly let inflation eat away all your savings. 

Risk is not a problem if it is calculated. Unmanaged risk or if you do not hedge your risks, then it becomes a real problem because you have ignored the risk completely. that gets you. The truth is risk is everywhere and you should figure out the balance that fits your own life and financial goals.