How risky is the ASX really? A data-driven review

Stocks are supposed to be risky - right? Just look what happened in 2008 (gasp!). But how risky are they really?

The key metric is time. Over what time period is an investment risky? Short-term volatility doesn't pose much of a risk to a long-term investment, and the risk of under-performance by a defensive portfolio grows with time.

Short term volatility and risk

Short term volatility hurts! Since 1 January 1980, the ASX All Ordinaries Total Return Index (XAOA) has increased in just over 63% of all calendar months. The best case scenario over a 1 month period was a profit of 17.43% and the worst case, a loss of 42.13%. (Yes, the crash of October 1987 was much steeper than the GFC. The worst monthly loss in 2008 was only 13.92%)

If you invested in the ASX 500 for a period of only 1 month during the past 40 years, you would have roughly a two-thirds chance of making money

But that's not how it ends! We can't all invest for the very long term, but the longer our investment horizon the less short-term volatility will impact our investment performance. For example, if you invested in the ASX 500 for at least 1 year during the past 40, you would have made money 78% of the time, an investment for 3 years made money 92% of the time and an investment for 5 years and 11 months always made money.

If you invested in the ASX 500 for a period of 5 years and 11 months or more in the past 40 years, you always made money

For long term investors, where is the risk in that?

Higher risk generally means higher returns

In return for bearing short-term volatility, the ASX has historically performed very well over the long term. For example, at the end of September 2018 the ASX All Ordinaries Total Return Index was at 63,599, which is about 63.6 times what it was worth when the index was created on New Year's Eve, 1979.

At an average return of 12.41% p.a. (including the 1987 crash and the GFC), the ASX 500 has consistently performed well over time.

Since 1980, the ASX All Ordinaries Total Return Index has returned an average of 12.41% p.a.

The risk of investing in defensive or 'safe' assets is that you may miss out on the upside potential of more volatile investment classes. A long term investor (i.e. 7 years or more) may risk much more by being out of the market, than being in it.

Want to invest like the rich? Check out my earlier article here. How about how to invest like a Billionaire?

Why Australian property was king (and why it may not be) - Some worked examples of successes (and failures) are set out here.

Note: This article contains factual information only and is not financial product advice. Readers should consider obtaining independent advice before making any financial decisions.