Chapter 5. The Rewards Outweigh the Risks

Stocks are risky. That's true of individual stocks you pick for yourself and stocks you hold within a mutual fund that are picked for you by the fund manager or index methodology. Also, bonds are risky. Bank savings accounts are risky, too. So are certificates of deposit, precious metals, and the cash you hold in your wallet.

All financial instruments hold some form of risk. Some that seem safe based on one type of risk are anything but safe based on another. Let's look at the types of risk investors face, and then see where stock-picking stands.

Capital Risk

Capital risk is the risk that the value of your investment goes down. Some investments have virtually no capital risk. U.S. government bonds are guaranteed by the faith and credit of the government. That means that the government's ability to make good on your bonds is limited only by the government's ability to take money from you in the form of taxes to make its bond payments. Bank certificates of deposit are guaranteed by the Federal Deposit Insurance Company, a government agency. It doesn't collect tax payments, but it does collect mandatory insurance premiums from banks.

Both U.S. government bonds and CDs are virtually free of capital risk, so long as you hold them until maturity. Sell a CD early and you may be penalized. Sell a bond before maturity and you'll sell it at the going rate investors are willing to pay, which may be higher or lower than what you paid.

Stocks, of course, ...

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