Saturday, 27 June 2009

Why Invest in Stocks? An Example in Practice

If you are a newcomer to investing, you may still doubt that you are capable of building a portfolio of stocks that will make you rich.

Not all stocks are going to live up to their early promise, no matter how much time you devote to making a selection.

In the other hand, even if you pick your stocks blindfolded, you will have some winners.

An Example

Investing into Common Stocks

Let's suppose that you want to invest $100,000 in 20 stocks, or $5,000 in each. Some will work out and some won't.

So so news - 10 of 20 stocks will just plug along

Hypothetically, it does not seem unreasonable to project that 10 of these stocks will just plug along, making you neither rich nor poor. Suppose we assume that these 10 stocks will appreciate (rise in value) an average of only 7% per year over the next 10 or 20 years. Toss in a 2% annual dividend and the total return adds up to 9% per year. That is not exactly riches, since stocks over the last 75 years have averaged about 11%.

At any rate, here is what your $50,000 will be worth at the end of:

10 years - $118,368

20 years - $280,221

Good news - 3 of 20 stocks performed above your wildest dreams

Next, let's look at the 3 stocks that performed above your wildest dreams. They appreciated an average of 15% per year. Add in a modest annual dividend of only 1%, and you have a total return of 16%.

Assuming you invest $5,000 in each of these stocks, that $15,000 will be worth over the next:

10 years - $66,172

20 years - $291,911

Bad news - 2 of 20 stocks skid and never recovered

So far, so good. Now, for the bad news. Two of your stocks hit the skids and never recovered. Total results for the $10,000 invested in these losers is: zero

10 years - $00,000

20 years - $00,000

Fair news - 5 of 20 stocks performed about average

Finally, 5 of your 20 stocks do about average. They appreciate an average of 9% per year and I have an average yearly dividend of 2%. That's a total return of 11%. Since you have 5 stocks in this category, your total investment is $25,000. Here is what you end up with in the next:

10 years - $70,986

20 years - $201,558

Adding Up these Returns

If we add up these various results, the final figures make you look reasonably rich:

10 years - $255,525

20 years - $ 773,690

Investing into CDs

By contrast, had you acted in a cowardly manner and invested exclusively in CDs that gave an annual return of 4%, you would have only the following at the end of the two periods:

10 years - $162,889

20 years - $265,330

One final note. If you figure in taxes, you look even better, since the capital gains (on your stocks ) are taxed at a much lower rate than ordinary income (which applies to CDs). And, you wouldn't even have to worry about capital gains on your stocks if you elected not to sell them.

(Comment: My personal guideline is this. Of 5 stocks you buy, expect 1 to do very well, 3 to be average, and 1 to do poorly.)

Read also:
Why Invest in Stocks?
Why Invest in Stocks? Look at the Facts
Why Invest in Stocks? Investing for the Long Term
Why Invest in Stocks? Some Profitable Comparisons
Why Invest in Stocks? Why Doesn't Everyone Buy Common Stocks?
Why Invest in Stocks? An Example in Practice

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