Why Stocks Are Safer Than You Think

Before you go, we thought you'd like these...
Before you go close icon

On Monday morning, TheWall Street Journal came out with a piece titled "Why Stocks Are Riskier Than You Think." The story encourages an investment in just about everything -- bonds, TIPS, options, and hedged ETFs -- except for companies on the stock market.

Though there was some sage advice in the column, Foolish readers should take comfort in the fact that most of the "proof" was quite selective, and once you look at the bigger picture, there's nowhere better to sock your long-term investments than in the stock market.

Ignoring the other half of the equation
One of the keys to the authors' argument was the fact that "the longer you hold onto stocks, the better the chance you'll run into a bear market." They then use this to argue that investing over long periods of time is, in fact, riskier rather than safer.

But there's a direct corollary that the authors conveniently forget: the longer you hold onto stocks, the better the chance you'll run into a bull market. Going all the way back to 1871, the stock market has produced annualized returns of 6.7% per year -- adjusted for inflation.

No advisor worth their salt would ever tell you to expect exactly that result every year. In fact, the market can be wildly variable. The past 10 years alone are proof of that, as the market actually lost more than 30% between 2001 and 2008, only to go on a ridiculous 105% gain from there.

The point still remains: Bull and bear markets are factored into the long-term equation, and neither can be ignored. There's nowhere else where you can average the type of long-term results that the stock market offers.

Bonds better than stocks?
The authors then follow up their warning about stocks by talking about the safety of bonds: "bonds outperformed stocks over the 30 years since the fall of 1981 -- delivering an average annual return of 11.5% vs. 10.8%, respectively -- with less risk and less volatility than equities."

We've actually already covered this one here at the Fool. The fact of the matter is that this 30-year reading is an anomaly; it's the first time it's happened. The authors counter this by stating that: "Since 1861, there have been only five non-overlapping 30-year periods! Statistically, that's simply too few independent periods to justify the conventional conclusions."

While that's true, the key word here is "non-overlapping." By using that word, the authors assume that the only time to get into bonds or stocks were at the beginning of every 30-year period (1861, 1891, etc).

Of course, that's not how investing works in the real world. If we were to take rolling 30-year averages (1950-1980, 1962-1992, etc.), we'd see that we have a sample size of 120, which I think is more than enough to convince the average investor that stocks will almost always do better than bonds.

Is this really simplifying?
Though most casual investors are able to wrap their heads around what it means to invest in bonds, the authors' suggestions for risk-averse investments in the market seem fairly complicated. They offer up a combination of options and "investment products that protect either principal or income by using hedging strategies involving various combinations of derivatives."

While these may end up being successful strategies, I tend to think that they are unnecessarily complicated and encourage investors to turn their money over to "professionals" to handle the confusing details.

But don't throw all the advice out
But as much as I think the data used for this argument are misleading, there are still nuggets of wisdom. For instance, they warn against playing catch-up with your investments for money lost in the Great Recession. Trying to get back money that you've already lost is a form of anchoring, and it can wreak havoc on your portfolio.

The piece is also careful to point out that you need to protect your safety net and make sure it's invested somewhere safe. Certainly, any money that you need -- or think you might need -- within the next three to five years should be stowed away somewhere safe and easily accessible (but probably not under your mattress).

There's a better way
For the average investor who wants to avoid the risky stocks, but still have a simple way to profit from the stock market, there is a better way: dividend stocks. By looking for companies with wide moats, solid business models, and stellar balance sheets, you can easily guarantee above-average returns for your investments.

I believe any one of these five companies offers excellent opportunities, and you should be very familiar with each of their easy-to-understand business models.

Company

Easy to Understand?

Dividend Yield

Payout Ratio

Coca-Cola (NYS: KO) It makes beverages, most of which you're likely very familiar with.2.9%51%
Johnson & Johnson (NYS: JNJ) A company all-things-medical -- it provides everything from Band-Aids to surgical equipment.3.5%64%
Procter & Gamble (NYS: PG) Check your bathroom; at least half of your products are likely from P&G. 3.1%60%
Waste Management (NYS: WM) The company that picks up -- and recycles -- your garbage on a regular basis. 4.1%67%
Paychex (NAS: PAYX) "Cuts checks" and sends them to employees of small and medium-sized businesses. 4.1%84%

Source: Yahoo! Finance.

Each of these companies will pay you for owning shares, and they all have room for growth in their dividend because of their low payout ratios -- though Paychex's is admittedly higher than the rest.

If, like me, you believe that the stock market is the best way to build long-term wealth, then I suggest you check out our special free report on dividends: "Secure Your Future With 11 Rock-Solid Dividend Stocks." Inside, you'll get 11 more suggestions for your dividend investing. Get your report today, absolutely free!

At the time this article was published Fool contributor Brian Stoffel no longer saves his money under his mattress. He owns shares of Coca-Cola and Johnson & Johnson. You can follow him on Twitter, where he goes by TMFStoffel.The Motley Fool owns shares of Coca-Cola, Johnson & Johnson, and Waste Management. Motley Fool newsletter services have recommended buying shares of Waste Management, Coca-Cola, Procter & Gamble, Paychex, and Johnson & Johnson; creating a write covered straddle position in Paychex; creating a write covered strangle position in Waste Management; and creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners