Maybe you don't currently invest because you think it's too risky. Or maybe you have owned stocks and over the past couple of years and have seriously reconsidered your investing strategy because your portfolio took a turn for the worse during the recent bear market and still hasn't recovered. If either of these situations describes you, you have company.
In the wake of the recent financial meltdown, many people have had trouble understanding why or how they should be investing in the stock market. To many, the thought of investing in the stock market has become nothing less than frightening. The vast majority of people have seen their portfolios take a dive, or at the very least know other people who have lost a lot of money in the stock market. As a result of the decline in the value of their portfolios, many people were forced to at least temporarily alter the direction of their lives or careers. Many people who were close to retirement needed to postpone retirement because their 401k's lost too much money.
Others have stopped investing in the stock market altogether. They decided that it was just too risky. If you are one of these people who has completely given up on the stock market or if you have simply decided to sit on the sidelines for a while, I would like to outline a few reasons that you should reconsider your investing strategy.
First, let's define investing. According to the Merriam-Webster Online Dictionary, the primary meaning of the word invest is "to commit money in order to earn a financial return". Using this definition, you can potentially classify a number of financial activities as investing.
Some people claim that putting money into a savings account is investing. You probably have a savings account. A savings account is a very safe place to keep money, since your deposited money is insured by the federal government up to $250,000. The problem is that savings accounts yield extremely low interest rates, usually much lower than the rate of inflation, which typically hovers around 3 percent. If your money is losing more to inflation than it is gaining in interest, then, since your aren't experiencing a real financial return on your money, is it really investing?
Money market funds, for most practical purposes, are very similar to savings accounts. They usually pay slightly higher interest rates than savings accounts, but typically have higher minimum balance requirements. Although these accounts can pay a higher interest rate than traditional savings accounts, the real return is extremely low when considering inflation. Also, as opposed to savings accounts, there is a very small risk of actually losing money with a money market fund.
CD's, or certificates of deposit, are also a popular financial vehicle that you are probably familiar with. CD's usually earn a slightly higher rate of return than savings accounts, but the interest rates are still very low compared to the rate of inflation. In addition, once you put your money in a CD you usually can't withdraw it without a penalty until the CD matures.
Bonds are another popular place that people put their money. With bonds, the rate of return depends on the risk involved. Short-term and government bonds are typically considered less risky, and therefore yield a lower return. On the other hand, long-term and corporate bonds typically carry a higher risk, and thus typically have a higher return. In general, bond returns are typically higher than both CD's and savings accounts, but the gap between the rate of return on an average bond and the rate of inflation is still relatively small.
The stock market is commonly and erroneously considered to be the most risky place to invest money. While it is true that stock prices vary in the short term, and sometimes widely, if you look at the long-term rate of return of the stock market versus other investment vehicles, the stock market has consistently and handily outperformed all of the other previously described investment vehicles.
Depending on the source you check, the long-term real rate of return of the stock market ranges anywhere from 8 to 10 percent. Comparatively, according to Charles Schwab, the average long-term return on Bonds is 3.6 percent. The return on CD's and money market accounts might range anywhere from 2 to 4 percent in the long-term. In addition to the higher long-term rate of return, individual stocks have virtually unlimited upward potential, whereas bonds and the other types of investments we have discussed don't have this type of potential. A stock could go from $20 per share to $40 within a matter of days or weeks if conditions are right.
On top of this, if you invest in an average stock mutual fund or index fund, your long-term rate of return might be around the overall stock market average of 8-10 percent. However, if you can train yourself to do your own stock research and weed out the underperforming or badly run companies, don't you think it might even be possible to earn even more than the 8-10 percent market average in the long run?
Let's briefly go over a brief example to illustrate the difference between investing in stocks and other lower-yielding financial instruments. If I invest $10,000 now, in 2009, and earn, on average, a modest 8 percent rate of return in the stock market, after 30 years I will have around $93,000. If I only earn a 3 percent return by investing in a money market fund or CD, I will only end up with around $23,565 after 30 years. Pretty big difference between the two scenarios, isn't it?
If you also consider the long-term rate of inflation at 3.42 percent (according to Inflationdata.com), your initial $10,000 would be equivalent to around $26,369 at the time you retire. In simpler terms, a car that costs $10,000 today would cost around $26,369 in 2039. This means that, in real terms, if you had invested in an account that only yielded 3 percent, you would, for all practical purposes, you would have essentially lost money on your initial investment. In other words, after 30 years you could no longer afford to buy the same car in 2039 that you would have been able to purchase with the original $10,000 in 2009.
Economic downturns, like the one in which we currently find ourselves, can be some of the best times to start investing in stocks. If you had invested in the stock market when the Dow Jones hit its low in the 6000's just earlier this year, you would've earned almost a 50 percent return on your investment in the ensuing months. Or, if you had invested in the Dow Jones in April of 1932, at the bottom point of the stock market crash during the great depression, in a mere 3 years your investment would have more than doubled, and would have more than quadrupled within 5 years. While it may be very difficult to time the market exactly right, being methodical and investing gradually over time can lead to big gains over the long-term.
In conclusion, investing in stocks can be a very profitable proposition. Over the long term, you are likely to make much more money and actually minimize your risk because you are likely to earn a higher average return than most other popular investment vehicles. If you are still unsure, test the waters by investing a small amount of money in a few blue-chip dividend-paying stocks or an index fund. Twenty or thirty years from now, you'll be happy you made the decision.
In the wake of the recent financial meltdown, many people have had trouble understanding why or how they should be investing in the stock market. To many, the thought of investing in the stock market has become nothing less than frightening. The vast majority of people have seen their portfolios take a dive, or at the very least know other people who have lost a lot of money in the stock market. As a result of the decline in the value of their portfolios, many people were forced to at least temporarily alter the direction of their lives or careers. Many people who were close to retirement needed to postpone retirement because their 401k's lost too much money.
Others have stopped investing in the stock market altogether. They decided that it was just too risky. If you are one of these people who has completely given up on the stock market or if you have simply decided to sit on the sidelines for a while, I would like to outline a few reasons that you should reconsider your investing strategy.
First, let's define investing. According to the Merriam-Webster Online Dictionary, the primary meaning of the word invest is "to commit money in order to earn a financial return". Using this definition, you can potentially classify a number of financial activities as investing.
Some people claim that putting money into a savings account is investing. You probably have a savings account. A savings account is a very safe place to keep money, since your deposited money is insured by the federal government up to $250,000. The problem is that savings accounts yield extremely low interest rates, usually much lower than the rate of inflation, which typically hovers around 3 percent. If your money is losing more to inflation than it is gaining in interest, then, since your aren't experiencing a real financial return on your money, is it really investing?
Money market funds, for most practical purposes, are very similar to savings accounts. They usually pay slightly higher interest rates than savings accounts, but typically have higher minimum balance requirements. Although these accounts can pay a higher interest rate than traditional savings accounts, the real return is extremely low when considering inflation. Also, as opposed to savings accounts, there is a very small risk of actually losing money with a money market fund.
CD's, or certificates of deposit, are also a popular financial vehicle that you are probably familiar with. CD's usually earn a slightly higher rate of return than savings accounts, but the interest rates are still very low compared to the rate of inflation. In addition, once you put your money in a CD you usually can't withdraw it without a penalty until the CD matures.
Bonds are another popular place that people put their money. With bonds, the rate of return depends on the risk involved. Short-term and government bonds are typically considered less risky, and therefore yield a lower return. On the other hand, long-term and corporate bonds typically carry a higher risk, and thus typically have a higher return. In general, bond returns are typically higher than both CD's and savings accounts, but the gap between the rate of return on an average bond and the rate of inflation is still relatively small.
The stock market is commonly and erroneously considered to be the most risky place to invest money. While it is true that stock prices vary in the short term, and sometimes widely, if you look at the long-term rate of return of the stock market versus other investment vehicles, the stock market has consistently and handily outperformed all of the other previously described investment vehicles.
Depending on the source you check, the long-term real rate of return of the stock market ranges anywhere from 8 to 10 percent. Comparatively, according to Charles Schwab, the average long-term return on Bonds is 3.6 percent. The return on CD's and money market accounts might range anywhere from 2 to 4 percent in the long-term. In addition to the higher long-term rate of return, individual stocks have virtually unlimited upward potential, whereas bonds and the other types of investments we have discussed don't have this type of potential. A stock could go from $20 per share to $40 within a matter of days or weeks if conditions are right.
On top of this, if you invest in an average stock mutual fund or index fund, your long-term rate of return might be around the overall stock market average of 8-10 percent. However, if you can train yourself to do your own stock research and weed out the underperforming or badly run companies, don't you think it might even be possible to earn even more than the 8-10 percent market average in the long run?
Let's briefly go over a brief example to illustrate the difference between investing in stocks and other lower-yielding financial instruments. If I invest $10,000 now, in 2009, and earn, on average, a modest 8 percent rate of return in the stock market, after 30 years I will have around $93,000. If I only earn a 3 percent return by investing in a money market fund or CD, I will only end up with around $23,565 after 30 years. Pretty big difference between the two scenarios, isn't it?
If you also consider the long-term rate of inflation at 3.42 percent (according to Inflationdata.com), your initial $10,000 would be equivalent to around $26,369 at the time you retire. In simpler terms, a car that costs $10,000 today would cost around $26,369 in 2039. This means that, in real terms, if you had invested in an account that only yielded 3 percent, you would, for all practical purposes, you would have essentially lost money on your initial investment. In other words, after 30 years you could no longer afford to buy the same car in 2039 that you would have been able to purchase with the original $10,000 in 2009.
Economic downturns, like the one in which we currently find ourselves, can be some of the best times to start investing in stocks. If you had invested in the stock market when the Dow Jones hit its low in the 6000's just earlier this year, you would've earned almost a 50 percent return on your investment in the ensuing months. Or, if you had invested in the Dow Jones in April of 1932, at the bottom point of the stock market crash during the great depression, in a mere 3 years your investment would have more than doubled, and would have more than quadrupled within 5 years. While it may be very difficult to time the market exactly right, being methodical and investing gradually over time can lead to big gains over the long-term.
In conclusion, investing in stocks can be a very profitable proposition. Over the long term, you are likely to make much more money and actually minimize your risk because you are likely to earn a higher average return than most other popular investment vehicles. If you are still unsure, test the waters by investing a small amount of money in a few blue-chip dividend-paying stocks or an index fund. Twenty or thirty years from now, you'll be happy you made the decision.
About the Author
Dan Cappel is an experienced investor and is dedicated to helping other people learn how to invest in stocks . Get FREE access to the exclusive stock research tools and information he offers today!
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