A Series on Why Investing in Stocks Still Makes Sense for Most Investors
By Ken Little, About.com Guide
The stock market may seem like a dangerous place at times.
The truth is that individual investors who try to beat professional traders will almost always lose. No investor can have the resources of hundreds of professionals working every day in the market like the big institutional investors.
Does that mean individual investors should avoid the stock market? Not at all, however it does mean that you need to be careful.
Here is a series of five articles that discusses why you should be an investor in the stock market:
The Five-Part Series
Part One: The Stock Market Doesn't Care About You
There are at least five good reasons you should continue to invest in stocks. This is the first of a five-part series.
This may seem like an oddly inappropriate time to suggest stocks, however, the benefits of investing in stocks have not changed.
What has changed (or needs to change) is the investing public’s perception of the stock market and its associated risks.
There are five good reasons you should continue to invest in stocks:
1. The stock market doesn’t care
The stock market doesn’t care about you or your plans. It doesn’t have any agenda and could care less about yours.
Why is this a good thing?
Despite what you may have heard on late-night infomercials or read in an unsolicited e-mail, there are no magic formulas for investing success.
There are no secrets of the rich and famous; no secret passwords or handshakes.
In truth, there is nothing standing between you and successful investing, but some hard work and understanding the fundamentals of investing.
While institutional investors have an advantage (more resources, more fulltime professionals), you still have access to all the information you need to be successful.
It may feel at times like the stock market is targeting you for disaster; it is not. If you are caught on the bad side of the risk equation (the higher the risk, the greater potential reward and the higher chance for failure), that’s just the reality of investing.
The stock market is most dangerous when investors forget the risk-reward rule and expose their holdings to too much risk, especially when there is not a full understanding of potential losses.
Investing in the stock market should be done with your eyes wide open. When you are blinded by a huge potential payoff or terrified of a loss, you will not make good decisions.
But don’t blame the stock market.
Part Two: Stocks Poised for Growth
Stocks are poised for growth.
Really? How do you know and when is this going to happen?
The truth is no one knows with certainty when the market is going to move up or down.
We can be guided by what has happened in the past and what logic tells us about today’s markets.
Historically, stocks have rebounded following a recession or a bear market. The rebound may have been swift or slow, but it has always happened.
The nature of the stock market is that it will rise until investors no longer feel confident of further increases. Then it will fall as investors sell to lock in profits or try to cut losses. Both of these actions drive prices down further.
At some point, investors will regain confidence that stocks are a bargain and return to the market to buy. As more investors move into the market, prices continue to rise and that attracts more investors.
Prices will reach a level that once again becomes uncomfortable and the cycle resumes.
Most investors know that the stock market does not move up or down in a straight line. It will move up then retreat and then resume its rise. The same is true on the way down.
Prices move in a zigzag fashion and it is sometimes difficult to tell when a trend will continue for the long term.
The notion that stocks are poised for a growth is also grounded in a belief that the U.S. economy is resilient and can weather even very difficult circumstances.
The real question that remains unanswerable is when the market will move in one direction for a sustained period of time.
That’s why long-term investors must be willing to ride out the down markets as well as the up markets.
As we deal with the changes of a very difficult economic period, investors should be aware that out of change comes opportunity.
Some of the companies that were industry and market leaders of the past will not adapt well or as quickly as others.
These are the circumstances when investors can achieve impressive gains by picking the new winners.
Follow the money, especially as federal dollars flow into new industries, such as green energy, and reforms in established industries (health care and financial services).
Part 3: New Regulations Will Level Playing Field for Stock Investors
More Transparency and Greater Oversight Will Be Good for Stock Investors
This is the third of a five-part series on why you should continue to invest in stocks.
New regulations will level the playing field for stock investors.
The stock market hates regulation. Many of its participants are hard-line free market advocates and believe regulation stifles innovation and adds extra costs to operations.
Thanks to years of little new in the rules governing the markets, a number of products and services are offered consumers that didn’t exist a decade ago.
For many, this has been a revolution and, for the most part, a good thing for the market.
Unfortunately, some took advantage of a laissez faire regulatory environment of the financial services industry and created products, services and partnerships that proved irresponsible.
The financial meltdown of 2007-09 can be directly tied to a financial services industry that was only concerned with generating as much profit as possible without regard to potential risk.
When the illusion of success disappeared, the financial collapse took down the global economy, casting millions out of work and out of their homes.
Yes, some of the consumers who willingly participated in this bogus economy are paying their rightful price, but many more innocents are paying too.
It is clear that our economy, not to mention the global economy, can no longer afford to be caught off guard by a financial crisis of this magnitude.
One of the repercussions of this crisis will be a financial services industry that is more tightly regulated, both in terms of the products it can offer and greater levels of transparency.
How does this benefit the stock investor?
A stronger regulatory environment that demands more transparency will mean investors will have a better picture of what the true risks are for an investment product.
Greater transparency will mean investors can make better decisions based on a more confident picture of the risks and rewards associated with an investment.
Will more regulation add to the cost of investing? Probably, but the benefits will outweigh the costs.
The stock market will not return to its robust former self until investors have confidence they are not going to be suckered into a legal scheme to enrich financial professionals.
Part Four: Stocks Offer Current Income and Long-Term Growth
A Series On Why You Should Invest in Stocks
This is the fourth of a five-part series on why you should continue to invest in stocks.
Stocks offer the potential for current income and long-term growth.
One of the major benefits of owning stocks is their ability to produce current income (dividends) and long-term growth.
The challenges of the 2007-09 financial crisis put a strain on some companies to reduce or eliminate dividends, but for strong companies, this is just temporary.
When the economy rebounds, some companies will be in better financial condition than others. Mature companies with established markets may be in an enviable financial position.
As is often the case, companies providing products or services to businesses may experience rapid growth. Companies that have curtailed spending during the economic crisis will play catch-up, scrambling to capture market share or protect what they still have.
As we work through a recovery, market-leading companies will become cash cows, throwing off extra income in the form of dividends and stock buybacks.
It is safe to assume that investors are going to be more wary of risk in the future. Companies with a consistent record of dividend payment and growth will command a premium in the market.
Increased regulation (see reason 3) may require companies to return more profits to its owners (shareholders).
It is almost certain that either through regulation or shareholder action, executive compensation and bonuses will come under close scrutiny.
Stocks that return more profits to shareholders may be viewed in a more favorable light by regulators and shareholders. Don’t be surprised if regulators encourage dividends through tax policies.
For investors, the combination of current income and long-term growth makes stocks a wise choice for those with a long time frame.
While there is still be much emphasis on quarterly profits, the investing community is likely to take a closer look at companies that have a longer term approach to growing the business.
With the right stocks in your portfolio, it is hard to beat the potential of current income and long-term growth.
Part Five: You Can Trade or Buy and Hold Stocks
Stocks Offer the Opportunity to Pursue Long or Short-Term Strategy
This is the fifth of a five-part series on why you should continue to invest in stocks.
You can trade stocks or buy and hold.
Stocks offer traders and investors opportunities for success. This is not unique among securities, but it does make equities a versatile investment.
Long-term investors (buy and hold) have found opportunities for success in picking good companies and riding with them until something changes the investor’s opinion of the company or its stocks.
Buy and hold investors are often ridiculed for riding a stock up, and then riding it right back down.
This is certainly a risk, but smart buy and hold investors understand that a good deal may not be good forever.
There is a time to hold and a time to take profits and move on to another opportunity.
The financial meltdown of 2007-09 fed the fire of criticism for the buy and hold strategy. Critics pointed to the many investors that saw their net worth plummet.
No one is immune from major market pullbacks, but with proper asset allocation and attention to what is happening in the economy, buy and hold investors have just as good of chance at success as traders.
Traders move in and out of positions based on what the market is doing.
One extreme is the day trader who closes out all positions at the end of each day. Other traders stretch their holding period as long as they are making profits, whether that is hours, days or weeks.
Traders also cut their losses quickly and move on to the next deal.
Are traders more successful than investors? That depends on whether you are comparing smart traders and dumb investors or the other way around.
Traders, also known as active investors, can be very successful if they are clever and work hard. You can say the same thing for buy and hold investors.
The bottom line is success with either strategy takes focus and hard work.
Which you choose (and some do both), is a matter of personal preference. Stocks give you the option to choose.
From Forbes