Purchasing power risk vs. market risk
2 common kinds of risk you’ll encounter in the financial world are purchasing power risk and market risk. This short video can help you learn about both.
Risk always plays a role in investing. It’s not the most comfortable topic, especially when markets are volatile. It’s easy to get stuck on thoughts of what we stand to lose.
But there’s a lot more to know about risk than you might think. And here’s a reassuring fact: You can control the amount of risk you take on when you invest.
It all depends on your asset mix. That’s the breakdown of stocks, bonds, and cash in your portfolio. Different assets carry different kinds of risk, and in different amounts. Here’s what you need to know.
First, let’s talk about purchasing power risk. When you keep cash in a bank account, it’s pretty safe—you won’t lose money. The downside, though, is that you won’t really make money, and the interest you earn over time may not be enough to keep pace with inflation.
Here’s an example of what that looks like. In 2010, the average price tag on a new car was $29,217. Fast forward to 2020: That price went up to $37,851. That’s inflation at work.
Say you decided not to buy a new car in 2010. Instead, you put your $29,217 into a savings account with a 0.6% annual interest rate and didn’t touch it for 10 years. By 2020, you’d have just over $31,000.
But that’s not enough to buy the average new car in 2020. Remember, they cost well over $37,000 now. Your low-risk investment didn’t keep up with inflation, and your money doesn’t have as much purchasing power as it did in 2010. And that’s purchasing power risk.
The idea of market risk might be a little more familiar. When you invest in the stock market, your share’s value goes up or down depending on economic variables we can’t control.
If you sell a fund for more than you originally paid, you make money. If you sell for less than you originally paid, you lose money. And that’s market risk.
You can learn more about investing risk at vanguard.com/LearnAboutRisk.
All investing is subject to risk, including the possible loss of the money you invest.
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