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 a 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 won’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 keyword 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 match 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?
In the lists of reasons for owning or not owning stocks, a lot of emphasis is placed on the investor’s beliefs. If investor A believes stocks aren’t a good investment and doesn’t buy them, and investor B believes they are a good investment and buys them, they are both acting in a manner consistent with their beliefs, but one of them is wrong. There is an objective reality independent of my beliefs. This independent reality will win out. Investors need to seek out truth rather than retreat into their fears and beliefs.
Understood, but as we’ve all learned, the truth can be quite elusive in the markets. In fact, it’s that very dynamic that makes a market. Every trade needs a buyer and a seller. Each, by definition, has a different belief about the prospects for that stock or financial instrument.
There may be other factors based on each investor’s personal situation as well. Maybe the buyer is a 30 year old who is just starting to invest in her future, and the seller is a 60 year old who wants to pare back his equity weighting before retirement.
I understand that fear can cause us to be too cautious. Perhaps that’s where I’m at right now. I may be wrong on the objective reality, but I’m OK with that.
I have been a long time reader but after reading your personal position is zero stocks and zero bonds, I lost a little respect for your financial advice. I know about your personal comfort but I would have expected a more BALANCED investment then just cash. If inflation is 2% and you are earning 3% of which you are taxed at the highest rate, you are not really coming out ahead. If you invested in solid long time paying dividend companies, you could easily get 6 to 8% at the lows. And some companies even increased their dividends. What GIC/bond will do that? NONE.
I respect your views Dave, and I understand your position. Just a couple of clarifications: this site is not intended to constitute advice. Rather, I try to cultivate an awareness of all personal finance options. I make my personal choices public in the interest of honesty and full disclosure, not as a means of promoting them to others.
Secondly, my investments are largely in RRSPs, so they will not be taxed until I take them out. If I invested in stocks within my RRSP and had significant gains, those gains would be taxed at my marginal rate, which would likely be higher than the taxes I would pay on the capital gains if I held them outside an RRSP.
You’re right. No bonds or GICs that are currently on the market will pay 6% – 8%. Can you guarantee that return with any stock, dividend-paying or otherwise? Some companies have increased their dividends. Many others have cut them, causing both a loss of capital and dividend income for investors. For us, I’m not interested in that risk for now. If it’s right for you or other investors, I respect that.
As for the balance thing, I explained in the last section that this position represents balance for us at this moment. I don’t recommend this allocation for everyone, but I think we need to consider our financial picture as a whole and not just in terms of our investments. We’ve hit quite a rough patch lately in other areas of our financial life, so I want smoother sailing and high liquidity in others. I hope that makes sense.
We can disagree and still be friends, right? 🙂
I like your articles and will continue to follow. It is just when you advocate you are a Balance Junkie and that you have learned a great deal about how markets work; it was a little disappointing to read that you are all cash in RSP. It was like Derek Foster, who I am a great fan of and have all his books and still follow, sold all his equity positions but preaches the “buy and hold” dividend paying companies. You lose a little respect for what they are saying. As a balance junkie myself, I maintained (through the recession) and maintain a similar balance as you stated in the globe mail column in my RSP.
But in the end it is all about how one sleeps at night.
Keep up the good work and look forward to more interesting articles.
Thanks Dave. If you’re talking about the 40-30-30 spilt I sketched out in the Globe, I think you’re on the right track. Not everyone is as risk averse as I am and I don’t know how much longer I’ll feel this way. But I’m guessing it will last until our income situation (or the global debt situation) improves. I’m hoping both will be resolved sooner rather than later!
Dave you could have spent a bit more time reading the article and you wouldn’t have had to make a completely pointless post.
I want to start investing in stocks, but I find a lot of the trading sites are for Americans only. 2 Cents- I would love if you would do a post outlining some Canadian trading sites, with info on how much per trade and how much of a minimum dollar amount you need to begin trading. I bank through Scotiabank so I’ve been thinking about trying their online ScotiaMcLeod, but I haven’t been able to find out what, if any, is the minimum dollar amount needed to begin.
Thanks for the question Shel. I don’t really have the resources to give that topic the thorough treatment it deserves. Luckily, The Globe and Mail does. They do an online brokerage survey each year that outlines the features and costs of each. Try this link:
There’s a lot of general information there as well, so I hope you’ll find it helpful. I believe Scotia’s brokerage has now become iTrade after their acquisition of E*Trade Canada. There have been a few criticisms of the E*Trade to iTrade transition, but you would probably be able to find customers that have had some type of bad experience with any of the brokers.
I will try to get a post up about general issues to consider, but for details, I haven’t found anyone that tops the Globe survey. For the record, I’m currently with Questrade. They have very cheap trades, but probably don’t provide as much guidance as other brokerages. That’s OK with me, but it’s not for everyone. Hope this gets you started!
Cool, thank you 🙂
Thanks for the balanced article 2 Cents. I am new to your blog so I missed your article when I posted a blog a few days ago on 10 must read articles on index fund investing. I will include a comment in the post with a link to this article since I like my readers to read it. Your article is not directly on index investing but a see a similar way of thinking.
The last 2 years have only confirmed my view on investing in stocks. I have had my journey during the last 15 years and fully agree with your reasons 5b&d why not to own stock (or what to look out for) and reason 2 why you do can own stocks. I think that some kind of market timing for the longer term trends is definitely possible (I do not try to time the market in time frames of days or weeks; only in terms of months and that goes very well).
I believe that life is too short to worry at night about your stock market investments. On the other hand, the market offers great opportunities to increase your savings and it is just pity if you do not use them. Therefore I have developed a systematic approach that works for me.
You’re correct about index investing. If I were invested, that’s the method I would choose. Thanks for stopping by and contributing your comments!
Jack Bouroudjian, who has been bearish on the markets for a long time, has now turned bullish and reckons that 2011 will be an excellent year ! I hope he’s right, it’s been a difficult couple of years.