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You Don’t Need to Invest In Stocks

February 20th, 2010 Leave a comment Go to comments

One of the first posts on the site was this one, which talked about the definition of an investment. There are many different things you can invest in, in addition to stocks. The criteria you should use to determine your investments should be based upon how well they fit your financial plan goals, or in some cases no goals (I sometimes invest in things that may be speculative or just for fun). You may not need or want to invest in stocks. Here are some considerations as well as a case study that demonstrates one option to a typical stock portfolio.

To give you an extreme example, let’s say you have a 25 Million dollar portfolio. You might be happy with current 5 or 10 year Treasury rates (2% per year or less) because even at that low rate, you will earn 500K per year and have a very low risk investment that won’t lose principal. Because preservation of principal is paramount, lower return investments can be selected.

So here’s some advice to consider.

Be Open To Other Investments

Wall Street offers many types of investments that aren’t stocks, plus there is a whole world out there of private market investments (real estate, energy investments, angel investing in start-ups, personal loans, social investing (so called peer to peer investing). Keep your options open.

Know Your Investment Returns

When you develop a financial plan, you will have an expectation of your returns (e.g.,  yearly cash flow, appreciation in value) that your investments will offer. This will drive what asset classes you need to fulfill your expectations. There may be ways to accomplish this without investing in stocks, so don’t assume this going in.

Also, resist the temptation to change your plan and expectations due to ‘water cooler’ talk where a co-worker talks about all the huge returns he is getting investing in ‘XYZ’, or whatever. Or some pundit who tells you the next great thing.

Know Your Risk Profile

A financial advisor may tell you that stocks outperform bonds, cash and real estate, etc. Stock out-performance typically comes with higher volatility, or beta, so to get those returns it’s a roller coaster. However, if you don’t feel comfortable with the risks that they pose don’t feel the pressure to buy them. There are alternatives that can work for you and enable you to succeed to fulfill your goals.

How Much You Understand Your Investments

The more you understand what you are invested in, the better the likelihood of your success. There are many successful investors who don’t own any stocks but invest in real estate, for example, because that’s what they understand most. If you don’t understand what you own you may fall victim to ‘buy high/sell low’, because you let external factors or emotions influence your decisions instead of fundamentals.

There will be periods when you may question what you own and wonder if you should own something else (like now). This doesn’t mean that you should always stick with what you own and never sell or change your investments. But, make these changes intelligently using facts and fundamentals.

A Case Study

Joe Ponzio as FWallStreet.com conducted an experiment to determine if he could beat the returns of the S&P500 index fund over a 40 year period (1967-2007) by investing in bonds. He invested in corporate bonds and developed a strategy of buying quality 10 year corporate bonds. As one would expect, stocks still beat this portfolio of bonds as they do for a similar portfolio of U.S. Treasury bonds.

But the difference in the return was less than you might expect. Here are the results:

On February 5, 2008, the two investors come together to compare portfolios. The stock investor is generally happy with her results. Over forty years, she has invested $98,000 of her own money and is sitting on $745,000. Her S&P 500 portfolio is generating more than $1,000 a month in regular income from dividends. She stayed the course, and she was rewarded handsomely.

The bond investor didn’t do as well. Also investing $98,000, he has just $609,000. As he faces retirement, his portfolio looks quite small compared to the “enterprising” stock market investor. Fortunately, the bond investor will find solace in his $3,000 a month income.

His conclusion:

And yet over 40 years, the difference between a well constructed bond portfolio and a buy-and-hold investment in the S&P 500 was just $39,000 when retirement hit.

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