Reasons to Own Stocks Even If They Are Only Average Investments
When I was a teenager, I spent some time at the local roller skating rink. In addition to enjoying the huge bell-bottoms and other clothes from the 1970s (the decade that taste forgot), I was puzzled by one of the establishment's rules. As an unskilled but thrill-seeking skater, I was constantly getting in trouble with the staff for skating too fast.
While I am sure that I did skate too fast, the rules made no sense. "No skating faster than average" was the law posted around the skating club. I spent many hours grappling with the logic. If even one person skates slower than the average, then by pure mathematics, someone else (and maybe many people) must be skating faster than the average. So the rule made no sense. The skating rink's employees were unimpressed with my logic, but I learned the mathematics of averages.
When it comes to investments, the logic of averages is unavoidable. No investment class can be above average indefinitely. Stocks have had a long run and are not cheap. So I don't recommend buying stocks in the hopes that they will have higher returns than other assets.
Even if stocks are only average, however, there are some good reasons to buy them. First, stocks provide protection against inflation and deflation. By buying stocks, and therefore the real assets that they represent, you are locking in purchases at today's prices. This means that if inflation rates rise, the value of those underlying assets should also rise. Similarly, if prices fall, the assets controlled by the corporation will also fall. So stocks provide protection in the event that the United States ' long run of almost perfect inflation rates ends.
Second, stocks provide protection against currency swings. Because many U.S. companies derive substantial revenue from international sales, stock prices are buffered against changes in the value of the dollar.
In 2003, for example, the U.S. dollar lost about 20% of its value against the euro, and lost substantial ground against most other currencies. 18
The decline of the dollar made most Americans poorer. When we go to buy a bottle of French wine or a car made in Japan , our dollars buy less. However, the earnings of many U.S. companies were helped by the decline in the dollar. Continuing our Microsoft theme, a piece of software that sold for 100 euros brought in over 120 dollars at the end of 2003 versus about 100 dollars at the start of the year. By selling the exact same product at the exact same price in foreign currency Microsoft reaped higher returns.
Stocks can be bought for risk-reducing reasons even if they are going to be only average investments. This is an interesting turn of events. Stocks are often thought of as the high-risk, potentially high-reward investments. It may be that stocks have become average investments with some risk-lowering features.
Another reason to buy stocks is the ability to avoid taxes legally. Both capital gains and dividends are subject to low tax rates. In addition, it is possible to build your own tax-advantaged mutual fund. The technique is to own a lot of stocks and to make sure that before the year ends, you sell enough of the losers so that your tax bill is zero. This feature of stocks has always existed, but until recently it was not feasible for most people because of high trading commissions. The online brokerage revolution has made it possible to legally defer paying taxes on stock market gains onlyaverageinvestments.
Just as a family loves all its children, even the ones who are not superstars, there are good reasons to own stocks even if they are going to be only average investments.
Even If You Do Not Buy Any Stocks, You Own a Lot of Stock
The final chapter of this book contains a summary of my recommendations for investing. For most people, my suggestion for stock investing will be lower than that advocated by Wall Street. Imagine for a moment that you follow my advice, or decide for other reasons to invest a modest amount in stocks. Now fast-forward 30 years to learn that stocks have done fantastically over that time. In 2035 you are looking back at your current financing decisions.
Many investors that I know have fantasies of having made huge bets at just the right moment. One of my friends correctly predicted the surge in biotech stocks in the late 1990s. He made some money on his investments, but missed much of the opportunity (some of the stocks he followed went from $5 to over $100 in a year). Almost every conversation with him includes discussing his fantasy of borrowing every dime possible and buying those biotech stocks for the entire ride. Many other investors speak of similar dreams—betting against stocks during the bubble days, buying after the terrorist attacks in 2001, and more.
Imagine our prudent stock investor who looks back on 30 years of stock market gains. The fantasy will be that she or he had invested every penny in stocks and made a ton of money. Even better, if time travel is invented, perhaps our investor in 2035 can travel back in time and change the investments. Wouldn't it be great to look in your retirement account some years from now to find that magically your financial decisions had been altered so that you had made the perfect set of decisions?
In Back to the Future, Marty McFly also wishes that he could change the world. Near the beginning of the film, he sees his mentor, the crazy professor, shot down by terrorists. Wouldn't it be great if he could go back in time and change events so that the professor is prepared for the attack? That is exactly what McFly does by warning the professor when he is time traveling. Armed with this knowledge, the professor still gets shot, but a bulletproof vest protects him.
So if U.S. stocks continue their 200-year run, we'll wish we could go back in time to adjust our financial decisions accordingly. The funny thing is that when it comes to stocks, even if you don't buy any stocks, you will most likely participate in any continued stock market rally. I've been making this point to my buddy Doug for years.
Doug was a college roommate who now runs a number of entrepreneurial businesses in Southern California (and has become quite a surfer). He made a ton of money during the bubble years, in part by a huge investment in Qualcomm. At one point during those euphoric days Doug owned 8,000 shares of Qualcomm. He went out surfing one day and came back to learn that during his two-hour surfing trip, the stock had surged by over $70 a share. So in a morning of surfing, Doug's investment in one stock increased by over half a million dollars! Not bad.
Even after the bubble broke, Doug was still ahead on his stock purchases. During 2001 and early 2002,1 constantly urged him to trim his stock holdings. "Do you think that stocks are going to decline further?" Doug asked. I responded by saying that my advice was not based on a prediction of the stock market. Frustrated, Doug said, "Why should I sell stocks if they are going to go up?"
I had Doug then draw up a list of his assets. He was a rich guy worth millions. This money was divided between California real estate, the value of his businesses, and his stock holdings. I then asked him to describe a scenario in which his businesses were in trouble. The answer was that his businesses would suffer serious decline in a recession. The final question was to ask Doug about the value of his stock and his real estate in this scenario. The answer was that if the economic conditions went south, all three of his major sources of wealth would decline together.
The conclusion was that even if Doug owned no stocks, his wealth would go up along with a stock market rise. Doug participates in any stock market boom even if he owns no stocks. His real estate and his businesses are worth more in the good economic times that foster stock market gains.
Similarly, most of us effectively own stocks even if we haven't bought any. Most importantly our job prospects probably go up and down with the stock market. If we put most of our financial eggs into stocks then precisely when we might need those resources because of problems in our lives, they are likely to be less valuable.
Most of us need not fear missing a stock market rally. If events turn out rosy, when we look back from the perspective of 2035, it will be as if we had stuffed our portfolios full of stocks. In a stock market boom, we are likely to enjoy high salaries and rising real estate values. If things turn out less perfectly, we will likely need the money that we have and be glad if it isn't all invested in risky stocks.