There is a payoff for accepting the uncertainty of higher-risk investing—assuming you manage the risk correctly.
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Investing is an imperfect science. While charts, data, and historic averages can hint at expected return rates, there’s always a gap between expectation and reality.
The gap widens as you take on more risk. For example, low-risk cash balances don’t fluctuate, but the yield and the buying power of cash can change. Higher-risk stock investments fluctuate in value and yield, often quickly.
Fortunately, there is a payoff for accepting the uncertainty of higher-risk investing—assuming you manage the risk correctly. To attempt to quantify that payoff, here’s a look at three investing scenarios involving a $500 monthly commitment for 20 years.
Three Investing Scenarios
These three high-level projections show how your choice of investments changes your wealth potential. Return assumptions came from an analysis by Aswath Damodaran at NYU that calculates geometric average returns by asset class, net of inflation, from 1928 to 2024. Calculations were made with the SEC’s compound interest calculator.
1. Low Risk
The projected ending balance after investing $500 monthly for 20 years is $123,129.50.
This scenario assumes you’ve invested in cash or three-month Treasury bills, which produce an average annual real return of 0.27%. The earnings, above and beyond contributions, are about $3,130.
2. Moderate Risk
The projected ending balance after investing $500 monthly for 20 years in a moderately risky portfolio is $169,505.83.
This scenario assumes 50% cash and 50% S&P 500 stocks, earning a combined annual rate of return after inflation of 3.49%. The earnings total $49,500.
3. High Risk
The projected ending balance after investing $500 monthly for 20 years in a high-risk, all-stock portfolio is $238,067.22.
This projection used 6.7% long-term average real return of the S&P 500, calculated by Damodaran. The ending balance consists of about $118,000 in earnings and $120,000 in contributions.
Risk Caveats And Considerations
Comparing the numbers, you might wonder why anyone would choose to earn $3,130 when it’s possible to earn $118,000. It comes down to uncertainty. Cash returns have a reputation for being a sure bet, while stock returns are notoriously unpredictable. This dynamic keeps many savers from dipping a toe into the stock market. The fear of losing money is a powerful force.
Two counterpoints are worth mentioning here:
- Cash returns aren’t as reliable as you might think. Damodaran’s analysis calculated cash returns for three timeframes: 1928 to 2024, 1974 to 2024 and 2015 to 2024. The averages for those periods were 0.27%, 0.55% and -1.19%, respectively.
- The risks of stock investing can be managed. You can minimize your risk of loss by diversifying via a broad market index and staying invested for at least 10 years. An extended timeline is important. When you review stock prices in one-year increments, there are many periods of negative performance—but far fewer declines happen over five or 10 years.
Extend the view out further, and this fun fact comes to light: The stock market has never lost value over 20 years. That’s not to say it couldn’t happen, but you are less likely to experience losses when you stay invested for decades.
Takeaways For The Cautious Investor
Buying stock is riskier than depositing cash. If it wasn’t riskier, no one would do it. The higher return associated with stocks is your reward for accepting added risk.
You can increase your wealth potential by shifting some of your regular cash savings into a broad market index like the S&P 500. To do this safely, though, you must commit for the long term. That means staying invested for decades, even if stock prices fall temporarily.
The Right Mindset
You can rationalize that commitment in different ways. One trick is to expect nothing from your investments, as if your contributions were just another expense. After all, you don’t expect earnings from what you spend on dining out or buying clothes. You accept these expenses as immediate losses to your net worth. If you think of investing in the same way—as money you can afford to lose—you’re less likely to panic and abandon your commitment.
There are pros and cons to that mindset. The advantage is that you can feel pleasantly surprised when your consistency pays off. The downside? The surprise might come with some regret, as you’ll wish you had invested more.
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