Showing posts with label equity investing. Show all posts
Showing posts with label equity investing. Show all posts

Sunday 18 December 2016

The Advantages of Stock Ownership



1.  Possibility for substantial returns

One reason stocks are so appealing is the possibility for substantial returns that they offer.

Stocks generally provide relatively high returns over the long haul.

Common stock returns compare very favourably to other investments such as long-term corporate bonds and U.S. Treasury securities.

Over the last century, high-grade corporate bonds earned annual returns that were about half as large as the returns on common stocks.

Although long term bonds outperform stocks in some years, the opposite is true more often than not.

Stocks typically outperform bonds, and usually by a wide margin.

Stocks also provide protection from inflation because over time their returns exceed the inflation rate.

In other words, by purchasing stocks, you gradually increase your purchasing power.



2.  Ease of buying and selling

Stocks are easy to buy and sell, and the costs associated with trading stocks are modest.



3.  Information easily available

Information about stock prices and the stock market is widely disseminated in the news and financial media.



4.  Cost to own stocks is low.

The unit cost of a share of common stock is typically fairly low.    

Unlike bonds, which normally carry minimum denominations of at least $1,000 and some mutual funds that have fairly hefty minimum investments, common stocks don't have such minimums.

Most stocks are priced less than $50 a share and you can buy any number of shares that you want.





Additional notes:

Investors own stocks for all sorts of reasons:
1.  the potential for capital gains,
2.  their current income, or
3.  perhaps the high degree of market liquidity.


Thursday 4 October 2012

A look at the stock/quotes table


Open any financial paper and you will see stock quotes that look something like the image below. In this section, we'll explain how to make sense of these tables so that you can use the information to your advantage.

Let's take a look at the stock/quotes table:

Columns 1 & 2: 52-Week High and Low. These are the highest and lowest prices at which a stock has traded over the past 52 weeks (1 year). This typically does not include the previous day's trading.

Column 3: Company Name and Type of Stock. This column lists the name of the company. If there are no special symbols or letters following the name, it is common stock. Different symbols imply different classes of shares. For example, "pf" means the shares are preferred stock.

Column 4: Ticker Symbol. This is the unique alphabetic name which identifies the stock. If you watch financial TV, the ticker tape will quote the latest prices alongside this symbol. If you are looking for stock quotes online, you always search for a company by the ticker symbol. If you don't know a particular company's ticker symbol, you can search for it at Yahoo Finance.
Column 5: Dividend Per Share. This indicates the annual dividend payment per share. If this space is blank, the company does not currently pay out dividends.

Column 6: Dividend Yield. The percentage return on the dividend, dividend yield is calculated as annual dividends per share divided by price per share.

Column 7: Price/Earnings Ratio (P/E ratio). This is calculated by dividing the current stock price by earnings per share from the last four quarters. (For more on how to interpret this, see Understand The P/E Ratio.)

Column 8: Trading VolumeThis figure shows the total number of shares traded for the day, listed in hundreds. To get the actual number traded, add two zeros to the end of the number listed.

Column 9 & 10: Day High and Low. This indicates the price range in which the stock has traded throughout the day. In other words, these are the maximum and the minimum prices that people have paid for the stock.

Column 11: Close. The close is the last trading price recorded when the market closed on the day. If the closing price is more than 5% above or below the previous day's close, the entire listing for that stock is bold-faced. Keep in mind, you are not guaranteed to get this price if you buy the stock the next day because the price is constantly changing, even after the exchange is closed for the day. The close is merely an indicator of past performance and, except in extreme circumstances, it serves as a ballpark of what you should expect to pay.




Column 12: Net Change.
 This is the dollar value change in the stock price from the previous day's closing price. When you hear about a stock being "up for the day," it means the net change was positive.

Quotes on the Internet
Nowadays, it's far more convenient for most people to get stock quotes off the internet. This method is superior because most sites update throughout the day and give you more information, news, charting and research.

To get quotes, simply enter the ticker symbol into the quote box of any major financial site like Yahoo FinanceCBS Marketwatch, or Quicken.com. The example below shows a quote for Microsoft (MSFT) from Yahoo Finance. The data can be interpreted exactly as it would if it were from the newspaper.


Read more: http://www.investopedia.com/university/tables/tables1.asp#ixzz28JJkx9Ou

Tuesday 25 September 2012

Even Lousy Investing Beats Not Investing

By Chuck Saletta September 18, 2012

It wasn't that long ago that we suffered through a period of time in the stockmarket that has come to be known as "The Lost Decade." The 10-year period between the start of January 2000 and the end of December 2009 was one of the worst for stock market performance, ever.
Yet even during those dark times, one very straightforward strategy would have allowed you to just about break even -- or perhaps even make a few bucks along the way. All you would have had to do is dollar-cost average into the low-cost market-tracking SPDR S&P 500 (NYSE: SPY  ) ETF and reinvest the dividends you received. That's one of the simplest ways to invest, and that strategy -- or one essentially equivalent to it -- is very often available in 401(k)s and other retirement accounts.
Although those returns were lousy, both in absolute terms and when compared to the market's long-run average, there's one strategy that it certainly beat: not investing at all.
The act that matters most
When all is said and done, doing what it takes to invest in the first place matters at least as much as the actual returns you get on your invested cash. There are several reasons for this. Perhaps the most obvious is that if you never put any money away at all, no rate of compounding will get that goose egg to ever be anything but a goose egg.
But on another, more subtle level, the act of investing itself matters because making the commitment to do it well requires the rest of your financial house to be in order. You need to be in control of your debts and have enough cash coming in not only to pay your bills, but also to put some away for your future. In essence, investing takes discipline -- the exact same type of discipline that will help you manage whatever sized nest egg you do manage to amass over your investing career.
Your potential $1 million payout from "lousy" investing
A typical working career may last in the neighborhood of 45 years. Having and keeping a consistent investing plan throughout that journey may seem like a daunting task, especially if we suffer through many more of those "Lost Decades." Still, as the table below shows, the reward at the end of the 45-year process may well be over $1 million, even while earning consistently lousy 2% annualized returns:
Monthly Investment
-1% Annual Returns
0% Annual Returns
1% Annual Returns
2% Annual Returns
$0$0$0$0$0
$100$43,499$54,000$68,162$87,466
$200$86,998$108,000$136,324$174,931
$300$130,497$162,000$204,487$262,397
$400$173,996$216,000$272,649$349,863
$500$217,495$270,000$340,811$437,328
$750$326,242$405,000$511,216$655,993
$1,000$434,990$540,000$681,622$874,657
$1,250$543,737$675,000$852,027$1,093,321
$1,416$615,945$764,640$965,177$1,238,514
Source: Author's calculations.
Granted, to reach the bottom line of that table, you'd have to contribute the maximum allowable $17,000 to your 401(k) throughout your career. Still, the $1 million nest egg at the end is an incredibly impressive result for only managing 2% annualized returns. No matter how challenging it may seem to sock away more than $1,400 a month, note what happens on that top line. If you don't invest at all, when it comes time to retire, you won't have anynest egg to tide you through your not-so-golden years.
The joys of lousy investing
Once you realize how important making the commitment to invest is, getting past the fear of investing poorly is much easier. You can much more objectively look at every investment you have made as either a place to earn or a place to learn. For instance, I view my investment in industrial and financial titan General Electric (NYSE: GE  ) as one of the best investments I've ever made. It was a good investment because of what I've learned from it, in spite of the lousy returns I've received along the way.
Indeed, the principles I learned from that GE investment -- looking for a strong balance sheet and a well-covered and rising dividend -- have yielded far more successful investments than failures over the years. When coupled with the third key lesson from that investment -- prudent diversification -- the experience formed the foundation of an investing strategy that looks capable of withstanding the test of time. Not bad for an investment with objectively lousy returns.
Often, investing does work out
Of course, not all investments turn out poorly, and in fact some wind up doing quite well. Over the course of an entire career, the combination of lousy and great investments in the context of an overall solid strategy could very likely exceed that 2% annual return level. But if you're planning for lousy returns and wind up with better ones, you'll end at a much better place. Yet no matter what your ultimate returns, it's having the foundation and the dedication to invest that matters most.


Wednesday 5 September 2012

Stocks and Bonds: Risk vs. Return



Take a good look at this chart.

It is a portfolio consisting of only 2 assets:  stock and bond.  

Here are some interesting points:  

1.  100% in Stock
This portfolio has the highest risk and also probability of the highest return.

2.  100% in Bond
This portfolio has low risk (NOTE: NOT THE LOWEST) and has lower return.

3.  50% in Stock and 50% in Bond
This portfolio has the same risk as and has higher return than the portfolio that is 100% in Bond.

4.  25% in Stock and 75% in Bond
This portfolio has the lowest risk and has higher return than the portfolio that is 100% in Bond.


(You may assume that holding cash giving an interest rate of 3% is the equivalent of holding a bond with a coupon rate of 3%.)


Conclusion:

Holding 100% in bond carries the same risk as holding 50% in stock and 50% in bond.  However, the probability of a higher return for the same risk should make investors favour holding 50% in stock and 50% in bondthan to hold 100% in bond.

For those who are very risk averse, for example in the present falling market, the lowest risk is the portfolio that is 25% stock and 75% bond, and not the portfolio that is 100% in bond.  Moreover, the portfolio that is 25% stock and 75% bond, offers a probability of higher return for lower risk, that the portfolio with 100% in bond.

Friday 10 August 2012

Avoiding Stocks Is a Big Mistake: Vanguard Founder

By Lee Brodie | CNBC – Mon, Aug 6, 2012

If you don't have money in the stock market (^GSPC) and you hope to retire someday, the founder of The Vanguard Group says you're making a big mistake.
John 'Jack' Bogle tells us if you're investing for the long-term don't get spooked by events of late. "Knight Capital is meaningless for anyone in the market for the long haul," he says. "In fact, you're probably in a mutual fund and you can pat yourself on the back for being smart."
In other words, for most individual investors the risk from Knight Capital is non-existent because most individuals hold a basket of stocks and the diversity of the basket hedges out the single stock risk.

And he takes issue with commentary from Bill Gross who believes "the cult of equity is dying."

"Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors' impressions of 'stocks for the long run' or any run have mellowed as well," Gross says.

The analogy of stock investing to autumn may be poetic, but it's not accurate and never will be, according to Bogle. "Equities offer higher risk and will therefore always generate higher reward," he argues. Therefore, "The cult of equity is never going to be over."
Bogle goes on to remind us that in 1979 BusinessWeek made the same argument.

The article came out right before the beginning of one of the greatest bull markets of the 20thcentury, Bogle insists. "It's always a question of balance but anyone who is out of stocks right now is making a big mistake.

Tuesday 31 July 2012

Why Stocks?

Past performance is no guarantee for future performance.  There are no guarantees that any asset will thrive in the future because it has in the past.

This leaves two choices:

1.  Keep hard cash and save enough during your working years to last your retirement years; or
2.  Take some risks and invest the money in assets that have a reasonable chance of increasing in value over time.

Keeping cash:  Most people cannot save enough to support them in retirement especially when inflation continuously erodes the purchasing power of money.  Therefore, most would not choose this option.

Investing the money in different asset classes:  Here is where the problem of choosing investment options comes in.  It is definitely wise to spread your wealth across various asset classes like stocks, bonds, real estate, art or gold.

Why Stocks
Stocks increase in value faster than inflation decreases the buying power of money.  The best way to have money in the future is to make money in the future.  So, forget about which asset class will appreciate in the future but rather focus on owning a business that profitably sells products or services.  Of course, most do not have the inclination, the money or the skills to start their own business, so the next best way to share in the profits is through the stock markets.

Stocks represent ownership interest in businesses.  When you invest in stocks, you become a partial owner of the concern that will hopefully make money in the future.  Stock ownership will reward the owners either because the stock prices go up or because the firm/s profits will be distributed as dividends.  In the short period stocks may rise for reasons having nothing to do with profitability or dividends.  But over the long periods of time it has been proved that stock prices rise in relation to a company's earnings and distribution of profits to shareholders in the form of dividends, bonus share and rights.  Learn and acquire the knowledge to consistently identify specific companies that will thrive.  In the absence of this ability, employ the services of a professional.

If you don't plan to tap into your long-term savings for a period of at least five years, stocks should probably constitute the bulk of your portfolio depending upon your emotional strength to deal with the ups and downs of the market.  Even retirees who draw their current income from their investments should have a portion of their savings invested in stocks so that their money will grow faster than inflation.

To be a savvy investor, know the difference between investing and speculating.





Thursday 12 July 2012

Asians Are World's Biggest Risk Takers

In times like these of volatile markets, who's got the guts to get in the fray? Apparently, Asians do. A survey by Nielsen shows Asian consumers are more likely to stay invested. What's more - they are also more likely to put their cash in high-risk assets than their peers in Europe and the U.S.
Nielsen's Global Consumer Confidence Survey on investment attitudes shows 48 percent of consumers in the Asia Pacific region said they were invested in the markets or used investment services. That compares to just 27 percent in North America, 21 percent in the Middle East and Africa, 16 percent in Europe and 13 percent in Latin America.
Asia's appetite for risk is also seen in investors' ability to withstand market volatility. Oliver Rust, the Managing Director of Nielsen says Asian investors tend to trade more aggressively and more frequently than their European counterparts.
More than half (57 percent) of Asia Pacific consumers say they're willing to accept fluctuations of more than 10 percent. Only half of investors in the U.S. will stomach those swings and just 45 percent in Europe.
Rust says Asian investors tend to have a higher proportion of disposable income allowing them to take more risks.
Disposable incomes in Asia are higher because a growing working population has led to more households with singles, or couples without children in Asia, according to a report by Euromonitor. In fact, it says disposable income per household from 1995 to 2010 grew 13.2 percent in the U.S., while in China it surged 230 percent.
Mark Konyn, Chief Executive of Cathay Conning Asset Management says Asia's risk-taking also has to do with attitudes. "In a Western context, taking risk is often viewed as speculation, rather than investment. In Asia's high growth economies, investors typically look for higher return opportunities and tend to have shorter time horizons."
Shan Han, a sales trader at IND-X securities adds that inflation is another factor. He says "higher inflation has also meant that hoarding cash has not been a good strategy for savings because of negative real deposit rates," prompting Asian consumers to seek higher returns.
Han cites Hong Kong as an example. During most of the 1990s, annual inflation averaged 8.5 percent, while 12-month bank deposit rates averaged 6 percent. That means investors who stashed their cash in the banks were losing 2.5 percent of their savings each year.
Within Asia, Hong Kong consumers tend to be the biggest risk takers. 55 percent of Hong Kong consumers are financial investors, outweighing the global average of 33 percent.
Rust says that has to do with "new money". "First generation wealth holders tend to focus on capital growth, whereas second or third generation wealth holders tend to focus more on capital preservation," he says.
That explains why a larger number of Asian consumers pick stocks as opposed to other asset classes such as precious metals and bonds. Almost three-quarters of respondents in Asia picked equities, even though they're often seen as the riskiest assets class. In North America, only two-thirds picked stocks, and in Europe, less than half did.



Wednesday 11 July 2012

Investing isn't easy, but the important parts are simple. Stocks or Bonds: The Easy Choice


Investing isn't easy, but the important parts are simple. 
  • Buy an asset when it's expensive, and future returns will likely be low. 
  • Buy cheap, and you'll probably do all right. 
There are ups and downs and booms and busts and lost decades throughout, but a basic appreciation of how valuation dictates the future can go a long way. 

Stocks or Bonds: The Easy Choice


No one knows what any market will do in the future. But with hundreds of billions of dollars pouring into bonds and 10-year Treasuries yielding 1.5%, it's worth taking a peek at what history says about the past. This quote, from The Economist, seems particularly relevant: "Investors who bought Treasury bonds at a 2% yield in 1945 earned a negative real annual return of 2.3% over the following 35 years."
Investing isn't easy, but the important parts are simple. Buy an asset when it's expensive, and future returns will likely be low. Buy cheap, and you'll probably do all right. There are ups and downs and booms and busts and lost decades throughout, but a basic appreciation of how valuation dictates the future can go a long way. It also shows why bonds produced such dreadful returns after 1945.
In the 1940s, interest rates had been falling for the better part of 20 years as the Great Depression drove knee-jerk risk aversion, and hit record lows as various policies and incentives moved to cheaply finance wartime deficits. According to Yale economist Robert Shiller, 10-year Treasuries yielded 5% in 1920, 3% by 1935, and 2% by the early 1940s. The consensus came to believe low rates were a permanent fixture. "Low Interest Rates for Long Time to Come," read one newspaper headline in 1945.
But as the saying goes, if something can't go on forever, it won't. By 1957, 10-year Treasuries yielded 4%. By 1967, 5%. They breached 8% in 1970, and zoomed to 15% by 1981 as inflation scorched the economy. Since bond prices move in the opposite direction of interest rates, this was devastating to returns. Deutsche Bank has an archive of Treasury returns in real (after inflation) terms, which tells the story:
Period
Average Annual Real Returns, 10-Year Treasuries
1940-1949(2.5%)
1950-1959(1.8%)
1960-19690.2%
1970-1979(1.2%)
Source: Deutsche Bank Long Term Asset Return Study.
Don't underappreciate how awful this was. In real terms, $1,000 invested in 10-year Treasuries in 1940 would have been worth $584 by 1979 -- this for an investment often trumpeted as "risk-free."
No one knows if the same performance will be repeated over the coming years. Japan is a good example of extremely low interest rates sticking around for decades. But the risks are obvious. With 10-year Treasuries yielding 1.5%, there is virtually no chance of high returns over the next decade. The odds of being hammered and suffering negative real returns are, however, quite good.
How about stocks? Here, too, no one knows what the future will bring. But history has an opinion.
The same Deutsche Bank study mentioned above shows that, after inflation, stocks produced an average annual return of negative 3.4% a year from 2000 to 2009. That was the third time since 1820 that stocks underwent a decade of negative real returns. Even during the Great Depression years of 1930-1939, stocks squeezed out a positive return.
Something else that sticks out from the study's nearly 200 years of history: Stocks have never produced back-to-back decades of negative real returns. Big booms have invariably followed long slumps. Stocks logged negative real returns during the 1910s, and followed up with blistering 16% real returns in the following decade. Returns went negative again during the 1970s, then shot to nearly 12% a year in the 1980s.
That may just be a quirk of the calendar. What matters are valuations. One of the best ways to measure the overall market's value is Robert Shiller's CAPE ratio, which calculates market price divided by 10 years' average earnings, adjusted for inflation. Its current value is 21, compared with an average of 19 since the S&P 500 began in 1957. So that's a little high. But here is where stocks' long-term superior gains come into play. Since 1880, the average 10-year return after CAPE at current levels is 7.7% a year, or about 5% a year after inflation. That's nothing to write home about, but it's almost certainly better than you'll achieve in bonds these days.
Unlike bonds, there are several good, high-quality stocks with long track records that can be purchased today at prices that set you up to earn decent future returns. A few I like areProcter & Gamble (NYSE: PG  ) , Colgate-Palmolive (NYSE: CL  ) , and Johnson & Johnson (NYSE: JNJ  ) .

Saturday 30 June 2012

Stock investments versus bonds are a ‘no-brainer’, says Warren Buffett


October 6th, 2010 by John Doherty

 Stock investments vs. bonds are a 'no-brainer', says Buffett
Stock investments are superior to investment in bonds, despite the general view that bonds investments are relatively low-risk, according to the world’s most successful investor, Warren Buffett.
Speaking at a conference for top US businesswomen organised by Fortune magazine, Buffett said of stocks investments: “It’s quite clear that stocks are cheaper than bonds. I can’t imagine anyone having bonds in their portfolio when they can have equities.”
For the world’s 3rd-richest man, with a personal net worth estimated at $47 billion in March 2010, low-risk investments may no longer be necessary – but even for the ordinary investor prepared to put their money away for a decade or two, the arguments for stocks and shares investments are what Buffett might call a ‘no-brainer’.
By charting the performance of a long-term investment in stocks and shares made in 1945, figures released recently by Scottish Widows shows that returns over a 60-year term were 70 times greater than investing the same sum as cash in a bank or building society account.
A sum of £100 invested in a building society account in 1945 would have been worth just £1,767 by 2006, according to Scottish Widows. Invested in bonds, the sum would have been worth £4,323.
However, the same £100 invested in the UK stock markets, as measured by the Barclays Equity Index and including dividends reinvested, would have grown to £125,243 over the same time period.
While bonds may be attractive for an investment of 5-10 years, as you are told in advance what your minimum return will be, stocks and shares investments are the clear winner in the longer term.
Warren Buffett’s investment activities are carried on through his investment company Berkshire Hathaway, which has been voted the world’s most respected company by the leading US business publication Barron’s Magazine.

Sunday 20 May 2012

Sunday 15 April 2012

Why Invest in Stock Market When There are Other Investment Options?


Advantages of Stock Market Investing

Why I Love Stock Investing So Much

Summarized Overview

In this article you will find information about reasons to why invest in stock market than other investment options, historical stock market performace from 1926 to 1999, short comparison to other investment vehicles, namely mutual funds, real estate and own a business.
Happy Investing!

Three Reasons Why I Invest in Stock Market

Advantages of Stock 1: Own Profitable Businesses

This is the major reason to why invest in stock market. Building own business might be your ambition, especially if you are an employee like me. But no matter how big or small the business you are going to build, it require A LOT of commitment, time and money.
With stock, owning a business is a lot easier, and cheaper too!. Just imagine, owning a business empire without ever showing up at work. You just have to sitback and relax, watch your company growing from time to time.
By the end of the year, you can collect checks from dividend issued. As your company grows, your stock valuation appreciates as well. You will be amazed on how much return you'll be getting by just holding them as long as possible. Does it sound too good to be true?
Advantages of Stock 2: Flexible Holding Position

You can buy more of the same stock if you find it profitable and undervalued. On the other hand, you can sell some or all of them if it is overvalued or the company losses money. Depend on your stock investing strategy, this flexibility can help you achieve your financial goal faster.

Unlike if you had your own business, even if it losses money, you have to stick with it and struggle to make it profitable to cover your ongoing overhead costs. Same goes to real-estate. If you made mistake since the first day you own the properties, you'll end up losing more and more money paying the mortgage with no rental income to cover.
Advantages of Stock 3: Can Do-It-Yourself
What is your primary
investment options?
Cash Deposits
Stock Market
Mutual Funds
Own Business
Real Estate
Others
I can analyze stock profitability, track stock performance, call my broker for transaction and organize my stock investing strategies all by myself. I just have to catch up with few financial ratios either from analyst reports, business magazines, local newspapers or simply from myannual reports collection.
With good time management and focus on your research, all these processes are not require a lot of commitment, really. You don't have tenant to manage, supplier to deal with or customer to face in stock investment.
Unlike mutual funds, you have an absolute control over your investment decision. I can still have fun with my families and concentrate on my working career but make more and more money.

Historical Stock Market Performance

Historical Stock Peformance

The average stock market is growing over time. Even excludingdividends paid, bonus issue or right issue, the stock market still able to grow 11 to 18 per cent per annum. Cool huh? Can you imagine if your stock has above average performace? Believe me, you can reach even 35 per cent return!
This is why invest in stock market is a very attractive options.


http://www.stock-investment-made-easy.com/why-invest-in-stock.html

Wednesday 28 March 2012

The Road to Building Wealth




The Four Principles

1 . Invest regularly.
You can begin by investing as little as $25, $50 or $100 a month. As your
resources grow, your monthly investment can grow. The important thing
is to invest on a set schedule over time.

2 . Reinvest earnings, dividends and profits.
If a stock pays dividends, reinvest them to buy more shares. If you sell
a stock, apply the proceeds to another investment.

3 . Invest in quality growth stocks and mutual funds.
With the right growth stocks and equity mutual funds, you can achieve
goals like doubling your money every five years with an acceptable
amount of risk.

4 . D i v e r s i f y.
A balanced portfolio includes companies of various sizes from different
industry segments and mutual funds from various categories. This kind of
diversification helps reduce risk and broaden investment opportunity



Also read:
Searching for Good Quality Growth Companies
http://www.investlah.com/forum/index.php/topic,23855.0.html

Saturday 3 March 2012

Investor of marketable shares has a double status, with the privilege of taking advantage of either at his choice.



The impact of market fluctuations upon the investor’s true situation may be considered also from the standpoint of the shareholder as the part owner of various businesses.

The holder of marketable shares actually has a double status, and with it the privilege of taking advantage of either at his choice. 

1.  On the one hand his position is analogous to that of a minority shareholder or silent partner in a private business.
  • Here his results are entirely dependent on the profits of the enterprise or on a change in the underlying value of its assets. 
  • He would usually determine the value of such a private-business interest by calculating his share of the net worth as shown in the most recent balance sheet

2.  On the other hand, the common-stock investor holds a piece of paper, an engraved stock certificate.
  • This stock certificate can be sold in a matter of minutes at a price which varies from moment to moment—when the market is open, that is—and often is far removed from the balance sheet value.



Wednesday 29 February 2012

Why Don't You Invest?



Last month, The Motley Fool posted a beautiful video titled "Why Do You Invest?"
"Is it for the fancy cars? The dream home?" the ad asks. "Maybe we invest for our families," it ponders, a reason I think most investors would agree with.
But there's a related question for millions across the country: Why don't you invest?
About 54% of U.S. households own stock investments, according to a 2011 Gallup poll. That leaves 46% that do not.
Part of this is due to a lack of wealth -- many American households simply don't have any money to invest. But there's more to it. A 2008 paper by a trio of economists showed that (link opens PDF file) sizable numbers of even the wealthiest Americans don't own stocks. 
  • Of households ranked in the third quartile of wealth, 34% did not own stocks either directly or through mutual funds. 
  • Of those in the top quartile, 14% had no stock exposure. 
  • Within the richest 5% of American households, 6% owned no stocks.

Some of the wealthiest households may avoid stocks because ownership in private businesses offers better opportunities. But for others, the excuses are more interesting.
Two centuries of data makes one point clear: Over the long haul, stocks trounce the returns of bonds, cash, commodities, and real estate -- and they do it with less risk. 
  • Adjusted for inflation, $1 invested in stocks in 1802 was worth $755,000 in 2006. 
  • In bonds, $1 turned into $1,083. 
  • Gold grew to $1.95. 
  • Cash depreciated to $0.06
During that 200-year stretch, the worst 20-year period 
  • for stocks produced a real return of 1% a year. 
  • For bonds, the worst period eroded half of investors' purchasing power. 
Stocks win over the long haul, and yet a large number of Americans avoid them.
Why is hard to know, but not particularly surprising. Americans' love for self-destructive financial behavior is never-ending. One incredible 2005 report (link opens PDF file) led by Yale economist James Choi showed that 
  • half of workers over 59.5 years old -- and hence eligible to withdraw money from a 401(k) plan right away -- do not contribute enough to retirement plans to take full advantage of employer matching, turning down money that would have been theirs to spend immediately. 
  • Two-thirds of those over 59.5 years old not participating in a retirement plan with employer matching said they would never sign up. It's astounding, as they could have pulled the money out the next day penalty-free.

Choi's paper doesn't detail attitudes toward stocks, but his results speak volumes about people's attitudes toward money in general. When something requires a modicum of effort, many Americans decline -- even if it offers substantial rewards. Our aversion to paperwork can be stronger than our desire for money.
Past performance also guides people's willingness to own stocks. 
  • While 54% of households currently own stocks, 
  • that figure was as high as 65% in 2007 when the market hit an all-time high. 
As USA Today wrote in 2005:
In 1996 and 1997, when the bull market was in full swing, Washington [state] gave its teachers an option of staying in the traditional pension plan or switching to a hybrid pension plan -- 50% of assets in a traditional pension and 50% in a private account. Seventy-four percent opted for the hybrid plan. But when public employees were offered the same choice in 2002 and 2003, after the slump, only 11% chose the hybrid offering.
Those who do invest in stocks tend to do miserably at it, reinforcing their perception that it's a losing game. 
  • One study by Dalbar showed that (link opens PDF file) the S&P 500 returned 9.14% a year over a 20-year period ending 2010, but the average investor earned 3.83% a year by buying high and selling low. 
  • Stocks crush bonds over the long run, but many would be better off in bonds so long as they stay put. They're that bad at investing.

Then there's the fear of being cheated. The same three economists mentioned above wrote a great paper (link opens PDF file) in 2008 asking a group in the Netherlands a simple question: "Generally speaking, would you say that most people can be trusted or that you have to be very careful in dealing with people?"
The question has nothing to do with stocks, but it was highly significant in predicting stock ownership. 
  • "Trusting others increases the probability of buying stock by 50% of the average sample probability and raises the share invested in stock by 3.4% points," the authors wrote. 
  • The results "explain the significant fraction of wealthy people who do not invest in stocks." The study is likely applicable to the United States.

Another possibility -- though one I don't have evidence for -- is that people willingly forego higher long-term returns to avoid the nausea of stock volatility. 
  • Academic economists tend to view people as unemotional "utility maximizers" for whom rational behavior equals whatever is most efficient, but the real world is different. 
  • Trading a percentage point of returns for a better night's sleep may be worth it for those who value a peaceful life over a large net worth
  • What looks irrational on the chalkboard often makes sense in the real world.

With pensions a dying relic, more Americans are now responsible for financing their own retirements. For most, the only way to get there is heavy exposure to stocks over many years. Will those now shunning stocks eventually change their minds? Will they ever get to retire? It's hard to know. Never underestimate people's willingness to undermine their future.