Should You Invest in Stocks?
Progress always involves risks. You can’t steal second base and keep your foot on first.
~ Frederick B. Wilcox
Regular readers know they’re not going to get a yes or no answer to the title question. If you’re new here, I will give you this one-word answer: maybe. The truth is, I don’t think anyone is qualified to answer that question but you. But I’m guessing you’re reading this to actually get a little information, so I’ll try to outline my take on the pros and cons here.
Much of what I write here and in comments on other sites often sounds a very cautious tone on equities (stocks). I’m afraid I may come off as someone who generally doesn’t like stocks or markets. That’s not the case.
In fact, I traded actively for a number of years and learned a great deal about how markets work – and occasionally don’t work. The more I learned, the more cautious I became. Still, I don’t think there’s anything wrong with owning or trading stocks if you know what you’re doing.
With regard to today’s opening quote, I want to clarify the metaphor a bit. It sounds like the quote is saying that you must take risks to make any progress. That doesn’t mean investing in stocks is the only way to make progress. In fact, you could get picked off (lose money) if you take on too much risk. You just need to have a plan. Any true baseball fan knows there are lots of ways to take second. You just need to find the one that works for you. Look for opportunities and only run if you’re pretty sure you can make it. 😉
5 Good Reasons Not to Own Stocks
1. Lack of Trust in the Integrity of the Markets: If you do not believe that markets are functioning ethically, you may not want to invest in them. Much has been made about the preferential treatment received by certain firms (especially Goldman Sachs) during the recent crisis. Having said that, skillful traders can pretty much navigate just about any market. The trouble is, most of us are not skillful traders.
2. You Don’t Buy the “Stocks for the Long Run” Mantra: I like Jeremy Siegel. He seems really nice. But I disagree with his idea that stocks owned over long periods of time outperform all other asset classes. This data has been used and misused by advisors for years to sell mutual funds to clients and to encourage high equity allocations. I don’t have the room to debate this in detail here, but you may want to take a look at an article by Jonathan Chevreau entitled Stocks for the Long Run’s Jeremy Siegel — Bull Market King or Clothesless Emperor? It outlines the ideas of Siegel’s supporters and detractors.
3. You Don’t Believe You’re Going to Receive 7% Per Year: A lot of people (usually in the financial industry) say that you can expect historical average returns of 7% or so from the stock market. That may be true. But your actual returns will be neither historical nor average. You will get whatever the market does after you make your purchase. It may go up or down by a little or a lot, and no one can tell you in advance what your return will be.
4. You’d Like More Balance in Your Portfolio: This isn’t really a reason not to own stocks. But it might be a reason not to have over 50% of your portfolio in stocks. Again, I can’t say what the correct percentage is for you. It depends on your income, age, risk tolerance, etc.. The Canadian Couch Potato had a great article recently asking How Much Risk Do You Need to Take? I think you’ll find it really helpful.
5. You Don’t Know Very Much about Stocks, Markets or Investing: If your investment knowledge is limited, you basically have a few options:
- Trust someone else to manage your money for you. Even if you choose this option, you still need to know at least a little bit about markets to ensure that your money is being managed wisely.
- Learn enough to do it yourself. What’s enough? It depends on how fancy you want to get with your investments. Keep it simple, especially at first.
- Stay out of the markets. You can keep your money in safe (but currently very low-yielding) CDIC insured instruments like savings accounts and GICs.
- Invest some of your money in the markets, but limit your exposure to a small percentage of your capital until you have learned enough to feel confident about putting more of your capital at risk.
5 Good Reasons to Own Stocks
1. Higher Potential Return Than Other Asset Classes: The key word here is potential. It is likely (but not guaranteed) that owning good quality stocks over a long period of time will give you a higher return, especially when interest rates are at historical lows as they are right now. But you will need to be able to stomach potentially steep drawdowns in your principle as well.
2. You Have a Proven Trading or Investing System: Whether you are an investor or a trader, you need to be confident that your system works. I am not one of those who will tell you that you can never time the market. I will, however, warn you that it’s a lot harder than it looks. 😉
3. You Have a Longer Investment Time Horizon: If you have a couple of decades until you retire, you can better afford to take the risks posed by investing in stocks.
4. You Are Fully Aware of the Risks You Are Taking: You understand that you may sustain significant losses if you are investing in stocks. You are willing to take that risk in exchange for the possibility of a higher return.
5. You Take Steps to Limit Your Risk: Whether you are a mach 7 trader or an ardent buy and holder, you must have some kind of exit strategy. If you’re a trader, use stop-loss orders and/or price targets to protect your capital. If you’re an investor, use a rebalancing strategy that forces you to take some profits after a big run and buy a little more after a drop (if the investment still makes sense).
My 2 Cents
My recently well-documented personal position is zero stocks and zero bonds. While that decision is based partly on my views on the current macroeconomic climate, it’s also based on our unique personal situation at the moment. We have recently experienced quite a reduction in both the amount and stability of our income.
It’s all about balance. We have increased volatility in one area of our financial life, so I have chosen to eliminate volatility altogether in other areas. It’s a personal choice. I think it’s right for us right now. It may or may not be right for your situation. Oh – and I could be wrong. I’m fully aware of all of that, but this feels like the right choice for us for now.
One of the reasons that I tend to emphasize the risks inherent in the stock and bond markets is that I truly am a balance junkie. I think the case for owning stocks is oversold. I’m just trying to get both sides of the story out there so that average people can make more informed decisions.
How do you view stocks? Has your view changed over the past 2 years?