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What are the risks of buying shares?

Tristan Harrison

Buying and owning shares is one of the best things you can do for your long-term wealth, along with simply saving money.

But many people seem to think that shares are risky.

Firstly, the name ‘shares’ or ‘stocks’ seems to break the obvious link of what we’re actually talking about. It’s the business market. People are buying and selling small parts of businesses.

Share price volatility

Everyone knows what the biggest businesses in Australia are like Commonwealth Bank of Australia (ASX: CBA) and Coles Group Limited (ASX: COL). They have been around for decades and will continue to exist for many years to come.

But the share prices of these businesses can shift dramatically in a short amount of time. They can move up or down more than 2% in a single day, which is the annual return from bank accounts these days.

But if CBA’s share price goes down 10% in a week it doesn’t mean the underlying business is 10% worse. If the CBA share price goes up 10% in a week that doesn’t mean CBA is 10% better either.

Share markets are made up of lots of different buyers and sellers every day, so of course they will have different thoughts about what price they’re happy to buy and sell for.

Indeed, I think volatility is the sign of a strength of the share market. You can buy a piece of Telstra Corporation Ltd (ASX: TLS), A2 Milk Company Ltd (ASX: A2M) or any other business immediately any weekday for a very low cost. Think how much hassle (and cost) you have to go through to buy or sell property!

Businesses go bust

Occasionally a business will go bust. That’s part of our world, it’s part of capitalism. There aren’t any large blacksmithing or candlestick making businesses because times change. Lots of new businesses are created too, like Facebook. 

Sure, try to avoid in businesses where it’s fairly obvious their industry is in systematic decline. Aim for businesses with healthy balance sheets that can survive a bit of trouble in a downturn. If you invest in good businesses that are growing and have long-term prospects then they’re unlikely to go bust for a very,very long time.

As long as you don’t take on debt to invest, the worst that can happen is you lose 100% of your invested money (which just doesn’t happen to the entire share market). But on the other side, shares can return much more than 100%. Share prices that go from $1 to $2 make a 100% return, over time you can see returns of 200%, 500%, 1,000% and so on if that investment keeps growing.  

You pay a high price

I’m sure you’ve heard the phrase “buy low, sell high”. I’m not going to talk about selling, but it’s quite easy to pay too high of a price for an investment.

Ultimately, the returns we make from our investments are determined by the price we pay at the start. If a share price goes from $10 to $200 and back to $100, the person that bought at $200 is in despair and the person bought at $10 has made 10 times their money. Two massively different scenarios for the same business.

You shouldn’t try to time the market. Being invested for the long-term and benefiting from compound interest is important, but if things seem highly inflated there’s nothing wrong with looking at another quality investment which is at a better price or simply waiting a month or two for a better entry point. No-one is forcing you to invest today.

The post What are the risks of buying shares? appeared first on Motley Fool Australia.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of A2 Milk. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2020