🌱 Howdy folks, welcome to Sprouts Finance. Where we help old ladies cross the street. Who said finance couldn’t be fun? 👏
Estimated read time: 4 minutes and 12 seconds
Today’s edition is written by Bean Sprout and I’ll bust some common investing myths and misconceptions that I’ve found can spook new investors. We’ll build on this next week when we explore different investment objectives and the considerations I made when creating my investing strategy. I’ve also thrown together a few questions at the bottom to test your knowledge. Today’s agenda:
🦑 Fact of the day: Not finance today, but squids.
🚨Risk vs return: Why higher potential returns aren’t always the better option
🎰Investing vs gambling: What’s the diff? Both are scary and stressful anyway
Key takeaways:
💡💡 Higher potential returns often means higher risk (we put two light bulbs cause that’s how important that is)
💡 Risk tolerance is the amount of risk/volatility you are willing to accept
💡 Longer time horizon typically means greater risk tolerance
💡 Gambling is up to chance at one point in time while investing risk can be mitigated through strategies
FACTS
🤯Fact of the day
A squid’s brain is shaped like a donut and the oesophagus runs through the middle. If a squid eats something that’s too big, it can cause brain damage. Source
🧸The bear market.
Whilst it’s true that Build-a-Bear is a form of a bear market, that’s not what a bear market refers to in finance. In short: bear market = asset prices are declining (20% lower than recent highs). A bull market is the opposite. Bull and bear markets can refer to other assets but typically refer to stocks.
MYTH #1: You want the investments with the highest returns
It’s not unnatural to want a product with the highest returns. More money = more good, right? RIGHT? Not always.
As Frankie Valli once sang about his investment returns and not his love interest:
“You’re just too good to be true, can’t take my eyes off of you.”
Investments with higher returns are typically more risky 😖. Higher risk means there’s greater volatility and a greater chance an investor could lose money, so they need to be compensated for that risk with a greater return. Simply put, if you expect stock A and stock B to have the same return, but there's a greater chance that stock B will be worth nothing, then everyone would invest in stock A (did we say ‘greater’ enough times? 🧐).
So low risk, high return investments don’t exist?
But probably not.
Investing will always involve risk, so it's important to know how much risk you’re willing to accept i.e. what’s the worst case scenario you could handle without reacting like Janet below (sorry non-Friends watchers).
This is called risk tolerance. Risk tolerance can be impacted by a number of factors including financial goals and investing time frame for investing. Theoretically, longer time horizon = more risk one should be willing to accept.
🙋♀️Wait, but why? Short term price movements today are much more impactful on the price of an asset in 10 days than say in 20 years. E.g. On 10 May 2002, Amazon stock was at $16.94. The next day it was around $14.80. 10 days later it was at $19.50 and 20 years later it was at $2,300. Clearly that one day movement meant little 20y later.
🤔Understanding risk tolerance can help decide if the potential risk vs potential reward is suitable for a particular investment strategy.
MYTH #2: Investing is as risky as gambling
Many people believe investing is the same as gambling. And that’s fair - in its simplest form you are risking money with the goal of making more money. I wasn’t immune to this thought process either! But they’re not the same. I put off buying my first stock for YEARS because it felt so risky and unknown. Now look at me, I write a free weekly email named after a baby vegetable. 🫠
Anyways, below we’ll clear up some common sub-myths of the investing/gambling myth above. #mythception
✅ Both investing and gambling involve taking risk
True - both do involve risking money.
❌ Both are as risky as each other
False - in gambling, you’re either winning or losing your entire bet at a point in time. Investing isn’t so binary.
❌ Mitigating risk in gambling and investing is equal
False - there are less ways to mitigate risk in gambling than there are in investing.
✅ Both have the objective of making money
True - both have the objective of making money.
❌ Over time you expect both to have a positive return
False - over time you expect investing to have a positive return whereas you expect gambling to have a negative return. Remember, the house always wins.
❓What else is different?
When you invest, you own an asset whereas when you gamble, you own nothing.
On the outside the two may look similar but in reality they’re very different. Kind of like a chocolate box that your family would always get gifted. The chocolates would look similar but one would taste glorious, one would taste like your brother’s socks and you never knew which it would be. Really it was just a game of chocolate roulette (pun intended) 😬.
(Clearly Forrest was an astute investor)
Q&A
We’ve got some questions/answers below for you to test your knowledge (or not, that’s cool too).
🙋♀️ Fill in the blank or select the right answer
❓Investments with higher returns are generally ___ risky.
More
Less
❓An investment should be assessed by the potential ___ vs the potential reward
Risk
Profit
Asset
❓If you have a longer time horizon, are you generally willing to accept more or less risk?
More
Less
👇 Answers
More, risk, more
That’s all for today folks - don’t forget to rate and share below if you enjoyed our content. Stay tuned for next week where I go through how I built my investing strategy!
How did you find today's email?
🌱🌱🌱🌱🌱 Amazing stuff, keep it coming!
🌱🌱🌱 Could be better.
🌱 I prefer eating sand.
DISCLAIMER:
None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.
great read. Thx Bean Sprout!