How Investing in Stocks Can Make You Richer
Ever since the market meltdown more than four years ago, millions of people have been too scared to even think about investing in stocks. Admittedly, the financial crisis and ensuing stock market crash cost plenty of investors a huge portion of the value of their portfolios, leaving them with losses that many of them could ill afford to suffer.
But the potentially much larger negative impact that the financial crisis had is still being felt today. Because of the fear that the market meltdown brought with it, entire generations of potential investors believe that investing in stocks is akin to playing a rigged game. Those who have been too scared to put their money to work in the market have missed out on one of the biggest market rebounds in history, showing once again that when it comes to investing, stocks offer growth potential that other investments just can't match.
Looking at the alternatives
When you look at current conditions, the case for investing in stocks looks even more attractive. Keep your money in a savings account, money market mutual fund, or other cash investment, and you'll be lucky just to earn any interest at all. Consider the impact of inflation on the purchasing power of your cash stash, and you'll realize that every day of so-called safety you get from having money in the bank comes at the cost of long-term erosion of your money's true value. Even if you lock up your money for a relatively long period of time, 10-year Treasuries yielding 2.2% are barely enough to stay ahead of rising prices, and that's before considering the additional impact of taxes.
When you look back further, though, the evidence favoring stocks is even stronger. It's true that by cherry-picking certain time periods, you can find occasions on which stocks underperformed bonds and other investments. For instance, in the 30 years from 1981 to 2011, bonds beat out stocks in terms of total return. But that comparison used a particularly well-chosen endpoint favoring bonds, as interest rates in the early 1980s were well above 10% and have fallen dramatically in the ensuing decades.
But overall, looking at good periods and bad, stocks have delivered stronger returns by far than bonds or cash. According to figures from Ibbotson, the geometric average of returns from stocks has come in at 9.3% over the past 85 years, versus just 5.1% for bonds and 3.6% for cash.
What those numbers really mean
The problem with percentages, though, is that they don't tell the whole story. But when you plug in realistic numbers to go with those returns, you can see how important they truly are.
For instance, say you're able to invest $100 each month and get the average returns listed above. With stocks earning 9.3%, your nest egg would build up to about $196,000 in 30 years. That compares to just $85,000 for bonds and less than $65,000 for keeping money in cash over that time period.
As you can see, the higher returns on stocks build in a substantial amount of protection from adverse markets. Even if you earn 2 or 3 percentage points below the long-term average, you'd still likely outperform bonds and cash. And if you're fortunate enough to invest in a period when stock returns are greater than the long-term average, then you'll reap even bigger rewards.
How to invest in stocks without risking everything
With stocks near all-time highs, being prudent about which stocks to invest in makes plenty of sense. As you explore opportunities right now, focus on a few key ideas:
- Use index funds or exchange-traded funds to get easy diversification with modest investments. Broad-market ETF Vanguard Total Stock Market makes a good starting point for many investors because it provides a mix of U.S. companies of all sizes, avoiding the need to have separate funds to add stocks of small and mid-size companies. Adding other ETFs can further diversify into stocks outside the U.S., with iShares MSCI EAFE providing broad-based exposure to stocks in some of the largest economies in the world.
- Look for short-term crisis situations with likely positive outcomes. For instance, Boeing took a big hit after its Dreamliner aircraft's battery safety was compromised. For a few months, the aircraft was grounded, leading to intense investor fear. Yet the company rapidly resolved the problem, and investors have once again focused on the multitrillion-dollar potential for future orders over the next 20 years, rewarding value investors.
- Be careful with high-priced, high-growth stocks. They can be the best performers in your portfolio, but you'll suffer gut-wrenching moves along the way. Netflix , for instance, soared to nearly $300 per share in 2011 before plunging 75% in the face of its ill-advised attempt to break up its DVD and streaming businesses into two separate companies. Just a couple of years later, though, Netflix has gotten its growth back, with higher prices having provided greater revenue and international expansion giving the company plenty of potential for future growth. The shares have more than quadrupled from their 2012 lows.
Step into stocks
Investing in stocks involves taking on more risk than many people feel comfortable with at first. But as a means to reaching your financial goals, owning stocks can help your money work a lot harder for you over the long haul.
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The article How Investing in Stocks Can Make You Richer originally appeared on Fool.com.Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. 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.
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