Risk and Return

Unlike most savings accounts, investments are not insured or guaranteed, which means your results are not predictable. While investment markets have some very good years — which in the world of investing is measured by total return — they also have years that aren't so good, and even an occasional year or two that are bad.

For example, in the 20 years between 1985 and 2004, the 500 stocks in the Standard & Poor's 500 Index, as a group, went up in value in 16 years and down in value in four years. The best year was 1997, with a total return of + 33.36%. The worst year was 2002, when the total return was – 22.10%. And the average annual return for the period was + 13.23%. Long-term government bonds also had four losing years in that same 20-year span, though they weren't the same years that stocks lost value, and the difference between the best and the worst years was less dramatic.

The part risk plays

The unpredictability of the year-to-year return means when you invest, you take some risk that your results could be disappointing or even that you could lose some amount of principal, or money you're investing.

So why would anyone put hard-earned money at risk? The reason is that investment return, or what you get back in relation to what you invest, can be substantially greater than the return on insured savings.

Here's a look at the average annual total returns of different types of investments since 1926. The investments with higher returns are also those that have posed a higher risk of losing money in some years:

Small-company stocks                    12.7%

Large-company stocks                    10.4%

Long-term corporate bonds              5.9%

Long-term government bonds          5.4%

US Treasury bills (= cash)                 3.7%

One key to making investing more successful is to approach it as a longer-term strategy. By choosing investments carefully and riding out the downturns, you help reduce the impact of a bad, one-year return on your portfolio.