Invest In Stocks, Even If Prices Rise
It might seem like a daredevil approach these days, but you should invest in stocks.
Yes, prices are higher than last month and much higher than the beginning of the year, but still…invest in stocks.
Why am I so sure? Because what really matters to your portfolio is not the stocks you buy but the portion that is stocks, relative to other types of investments.
A younger person with a long time until retirement is going to own more stocks. A retiree who is the edge of taking out required minimum distributions is going to own less.
Less, mind you, not zero. Interest rates remain very low, so even older investors need to invest in stocks. They might be largely blue-chip dividend paying stocks, but that’s okay.
The reason why is inflation. If (and when) it picks up again, your portfolio will need a way keep pace. The research shows that stocks provide investors with reliable long-term growth.
They also bring volatility — that up-and-down motion that makes people on cruises turn a bit green and sometimes scares novice investors out of their holdings.
If you’re in that camp (the novice club, not the seasick club), then owning stocks can seem scary in any market, never mind one setting new all-time highs. That’s understandable.
Here’s the thing: Holding cash is a bigger risk than you might guess. Inflation is the reason why. Your cash is losing value.
Owning only fixed income, or bonds, brings us another kind of unseen risk. If interest rates rise, bond prices fall. If you own a bond fund, the value of those shares declines.
If you own bonds directly, you could hold them to maturity. But then the inflation problem kicks in. A bond paying 2% a year when inflation is 3% is losing 1% a year. Your get your money back with interest but the dollars are worth less in purchasing power.
A stock is a pretty simple investing. It’s a claim on the earnings of a private company. If earnings are growing, more people will want the stock. Demand usually means a rising share price, resulting in capital appreciation when you sell.
Invest in stocks and rebalance
Along the way, you get a piece of those earnings. In many cases, it’s in the form of a dividend or stock buybacks. Or, the company reinvests in itself, increasing (one presumes) the value of your investment. Add capital appreciation and the dividend together and that’s your total return.
When should you sell? In an investment portfolio, you sell when the capital appreciation outpaces the rest of your portfolio.
When should you buy? Well, sometimes the market will decline. Then you use incoming contributions or cash from your bond interest and dividend income to buy more shares while they are cheaper.
That’s rebalancing. Owning stocks is not a frightening prospect for investors with well-designed portfolios. Really, it’s just one of several asset classes that investors should own, whatever the market is doing right now.
Courtesy of Forbes Magazine