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In my first article in this series, I got just about as basic as you can get, looking at exactly what investors get when they buy a stock. I know some readers may be itching to get right into it and start figuring out which stocks to buy, but others may not even be convinced that buying stocks is such a good idea. So let's go ahead and take a look at why you would even bother investing in stocks. After all, there's a nice, warm spot under your bed for your cash, right?
3 cheers for stocks
The stock market can seem like a bit of an intimidating beast. Turn on CNBC during market hours and you're met with 15 different rapidly scrolling bars on the screen showing a gibberish-looking array of letters and numbers, while commentators -- sometimes five or more at once -- frantically shout in the middle of the screen. Not exactly a welcoming picture.
But for many investors, it'd be a mistake to exclude stocks as part of their portfolio. While investors will have their individual situations, there are three primary reasons everyone should at least consider stocks.
- Returns. Over the long term, stocks have delivered impressive returns. According to the 2002 edition of Jeremy Siegel's book Stocks for the Long Run, stocks returned 6.8% per year above inflation between 1871 and 2001. That compares with a loss of 0.1% per year for gold and an average gain of 2.8% per year for bonds. Cash, of course, almost always has a negative return as it earns nothing and simply absorbs the impact of inflation. But over the past 10 years, the stock market has actually fallen more than 6% as measured by the S&P 500, which is a good reminder that the returns from stocks may not always be consistent. However, the stock market's history gives us good reason to think that over longer stretches investors can do very well.
- Ease. Though at first the stock market can seem intimidating, it's actually one of the easier investments you can make. Once you have an account set up with an online broker, investing in a stock or a stock fund is as easy as clicking a mouse. The same is typically not true of investing in an apartment building, a race horse, a Picasso, or a vineyard.
- Diversification. Investors with all of their eggs in one basket are betting an awful lot on what happens to that basket. Investing in stocks in general not only gives you exposure to a different asset class, but it also allows you to invest in such disparate areas as multinational software companies, U.S. fast-food restaurants, or Chinese oil companies.
But how should you invest in stocks?
Just because you may be convinced that investing in stocks is a good idea doesn't mean that you have to try to be the next stock-picking genius. In fact, this isn't the ideal approach for most investors. Fortunately, there's a very simple way to figure out which approach to stock investing you should take.
Ask yourself this question: How much time am I willing to dedicate to studying companies, reading financial reports, and doing other work necessary to identify and keep track of top-notch stocks? Now don't just skip over this. Take your eyes away from your computer screen for a moment and really think about it.
Have your answer? While there isn't a specific number that I would say pushes you in one direction or another, the way you thought about that number tells the tale. If you found yourself begrudgingly thinking "Well, I guess I can put X amount of time into it because I know I have to," then we'll call you a Category One investor (more on that in a moment).
If, on the other hand, you're excited enough about stocks and learning to invest that your thought process was, "I'm willing to put in whatever amount of time is needed -- this sounds interesting and fun," then you can take a seat with the Category Two investors.
Category One investors
There's nothing wrong with not being interested in stocks. I love researching companies, I don't enjoy lobster, and I hated the movie Titanic. We all have our individual interests and preferences.
However, as we discussed above, there are good reasons for almost everyone to have some amount of their portfolio in stocks, so we need to discuss options for investors who would rather not spend much time on their investments. One option is to hire a financial advisor to help you out. This can be a great way to handle the situation since it relieves you of the time commitment and puts it in the hands of someone who is presumably well-versed in the field. If you choose this, though, the onus is on you to make sure that you are investing with someone that actually knows what they're doing and, maybe more importantly, will respect your wishes.
Another option is to do it yourself and simply stick with low-cost index funds. Funds such as the Vanguard 500 Index Fund (FUND: VFINX ) and the Wilshire 5000 Index Fund (FUND: WFIVX ) simply match the performance of major stock market indexes and assess very low fees on investors. Returns from index funds will, by definition, never "beat the market," but it's just about the easiest way to invest. For those interested in this type of investing, the works of Vanguard founder Jack Bogle are a great place to start.
Category Two investors
Ben Graham -- who is basically the Yoda to Warren Buffett's Luke Skywalker -- wrote in his book The Intelligent Investor that the investment approach that an investor should take depends largely on "the amount of intelligent effort the investor is willing and able to bring to bear on his task."
For investors willing and able to put in the necessary time and effort for research, investing in individual stocks can be a rewarding experience both financially -- if you're able to find stocks that perform well -- and educationally.
For the investors who fall into this group, be sure to stay tuned -- the remaining articles in this series will be aimed at you and specifically focused on how to invest in individual stocks.
In the meantime, head down to the comment section and feel free to raise questions about this article or offer suggestions for future articles in the series.