Many people afraid of investing in equities because they consider stock markets as a casino where only the bank wins. But are stocks risky as an investment? The answer is -as usual- it depends. But with a little bit of self discipline and a long term investing horizon, investing in stocks can be the best way to boost your portfolio value.
One of the main reasons why people consider stocks as a risky investment is because they get their information from the most “authentic” sources. These are typically the neighbors, colleagues, taxi drivers etc. And they are typically the type of investors that burn themselves at the stock markets. The two most common mistakes are:
Mistake no.1: Buy high, sell low
You buy either the most trendy stock, or the whole market via an ETF and wait to become a millionaire. This waiting period usually lasts until there is a (smaller or bigger) market crash, when you sell everything in order to avoid further losses.
Of course this is not the way to become a millionaire. They way to get there is more like this:
You don’t have to go back far in the past to identify some great opportunities to lose money with stocks. The below chart shows the S&P 500 performance from mid-2000 until today.
As you can see on the chart, if you invested a lump sum in mid-2000, by early 2003 the value of your investment has nearly decreased by 50%. In case you were very patient, in 2007 you were in a slight positive zone, just in order to experience another 50% drop until early 2009. The markets haven’t reached the levels of 2000 until 2013.
Besides of these two market clashes there is another important thing on the chart. Look at the upper right corner. If our investor was patient enough (and hasn’t jumped out of the window yet), by today his investment would worth 70% more, which is over 3% annualized return.
Needless to say, that if he was smart and patient enough to invest regularly, due to dollar cost averaging the returns would be much higher, as those market sell offs would have been used as an opportunity to buy cheap.
Mistake no.2: Don’t diversify
If I could give 3 advises for stock market investors, those would be: diversify, diversify, diversify! That is why diversification has such an important role in my ideal portfolio.
- Related article: Searching for the Perfect Portfolio – Conclusion
Yes, you can earn huge money by putting everything into one stock, like the 625% return in one year with Solar City between 2013 and 2014…
… or have 74% loss, like with Solar City between 2014 and 2016.
Investing in Index ETFs
If you don’t want to pay particular attention to the stock market, or you don’t want to follow the performance of individual companies, index ETFs are a great and low cost investment vehicles. On a long term, equities have always outperformed bonds and bills, so it would be crazy to let such opportunity pass by.
Every year, Credit Suisse issues their Global Investment Returns Yearbook. In the 2017 one they have included the below chart:
What you can see here is that on a really long (1900-2016) time frame equities always have outperformed bonds and bills. No matter how optimistic I am about my future lifetime, the shorter (16-19 years) periods seem more interesting for me.
Between 1980-1999 equities also won on a global basis (10.6% annualized returns vs 6.6% returns of bonds). Even in those few individual countries (Austria, Canada, Japan) where bonds performed better, the results were very close.
Between 2000-2016 bonds seem to be the better performer (globally 4.8% vs 1.9%). This is not necessarily surprising, considering that during this period we saw two market crashes (2000 and 2008). In addition, around 2000 the interest rates were much higher (in the US around 6%), so locking those in your favor was a good strategy.
If we look at today’s situation, the current low interest rate environment (especially in Europe) does not suggest for me that bonds would be the best investment in the foreseeable future…
So dear readers, you judge: Are stocks risky as an investment?
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Disclaimer: This post or any other information on the site is not intended to be and does not constitute financial advice or any other advice. I am solely sharing my idea, plan and progress on financial independence and early retirement.