2012年7月11日 星期三

Why You Need Stocks


During the market crash of 2008-9, many investors swore off stocks for good. So disillusioned were they at losing 30-40% of their portfolio that they sold everything at a loss and vowed "never again."
In retrospect, they look pretty foolish. Although the stock market hasn't regained its all-time highs, those who bought in over a period of years are probably ahead of the game. They certainly haven't lost 40%.

Why "Safe" Investments Aren't

Unfortunately the uninitiated and poorly informed overvalue the "safety" of bonds, certificates of deposit and other conservative investment vehicles. Because they fail to account for inflation, they fail to understand just how risky these "safe" investments can be.

Let us take certificates of deposit and treasury notes first. Suppose that you find a 5-year certificate of deposit yielding 3%. This may feel like a very safe investment. After all, in five years you are virtually assured that you will get your money back and another 3%, compounded, besides. But now consider what happens if inflation heats up during the second year and rises to 7%. You are now stuck in an investment that pays only 3% and you can't get out of it without paying a penalty. Worse yet you're earning only 3% per year, but the value of your money is eroding by 7%. Thus, in terms of purchasing power, you're actually losing money on your safe investment.

The Risks of Bonds

What about bonds? Here the picture can be even worse, because the safety goes down. Your bond issuer might default on the debt. Even if that does not happen, the value of the bond goes down as the interest rate goes up. Who would want to buy your bond yielding 3% when they can buy one yielding 7%? Of course assuming no default, you'll get all of your money back if you hold to maturity, but your money will have lost purchasing power just as in the example above.

Why Stocks Are Less Risky Than You Think

Over the long term, stocks are virtually the only investment that has been shown to consistently beat inflation. There may be long periods of low performance, but these are eventually outweighed by the boom times. If you are worried about safety, the best thing you can do is dollar-cost-average into a broad-based index fund over a period of years. You won't earn the highest returns doing this, but you won't get clobbered either. Moreover, you can do it without spending hours researching stocks and funds or lying awake nights figuring out what to buy and sell.

The bottom line? Those who are not independently wealthy and hope to be able to retire someday need to have a significant percentage of their assets in the stock market. Invest internationally as well as domestically and in many different sectors for the best risk protection.

Does this mean you should put all of your assets in the market? Definitely not. You should never put yourself in a position to be forced to sell your stocks during a downturn. This means the market is not appropriate for your emergency money or your short-term funds. Any money you expect to need within the next five years should be held in money markets, certificates of deposit, or low-volatility investments. Your stock portfolio should include some stable high-yielding issues so you can draw on the dividends to take advantage of new opportunities in the market. But it should also include some faster-growing small and midcap companies, as well as some exposure to emerging markets. If you avoid day trading and panic selling, these shares will be the source of some very good long-term gains.

Conclusion

Most investors misperceive risk, overestimating the long-term risks of stocks and underestimating the risk of fixed-rate investments. Stocks are an essential part of a well-balanced portfolio, but should not be used for emergency funds and short-term funds.




Investor from Main Street brings knowledge, insight and analysis to Wall Street.
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