Let's discuss the words "Risk" and "Safe"

I blame the English language, because our words have very different meanings depending on context. "Risk" and "Safe" are two of those words.

Let's start with "Risk".

Risk is most often associated with potential of injury or death. For example; "Skydiving is risky."

Therefore when referring to investments, the natural inclination is to interpret the word as meaning potential for partial or total financial loss.

That can certainly be the case. For instance, an individual stock can halve in price because of poor management, or after a hype cycle. But the more diversified a portfolio or fund is (i.e. multiple companies and industries) the less "risk" means potential for partial or total financial loss and the more it refers to the volatility of it's price.

This is crucial, because price volatility is a good thing if you plan to own the asset long enough to ride out the cycle!

The "risk premium" principle means investors demand higher returns in exchange for enduring changes in price, so broadly speaking, higher volatility will lead to higher returns over time.

Now let's talk about "Safe".

When referring to investments, in the same way "risk" can either mean potential for financial loss or price volatility depending on the context, "safe" means the opposite.

So the interesting thing is something can be both "safe" and "risky" at the same time!

For example, an index fund of growth stocks may have high price volatility and thus be a "high-risk" asset, while also being "safe" because it is well diversified and the probability of long-term partial or total financial loss is realistically 0%.

How should you apply this to investing?

It's important to select an appropriate level of "risk" based on your investment objective and time horizon.

If you plan to spend the money in 6 months (e.g. to buy a house), then you want very low risk (low volatility) assets such as money markets, CDs, or a high-yield savings account.

On the other hand, if you won't spend the money for 5+ years, then you have time to ride out most volatility and can be invested in high risk (high volatility) assets like growth stocks, high-yield bonds, etc. that will produce higher average returns.

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