Many, if not most, financial advisers recommend accumulating wealth from a diversified set of investments including stocks. An investor can add stocks to her/his portfolio by purchasing stocks from an individual company or from buying mutual funds. With the stock market down double digits since the beginning of 2020, some experts say stocks are “on sale” and now is a good time to buy, but just over half of Americans report they own stocks. This is down from 62% prior to the 2007/8 recession and it includes ownership of stocks that are contained within retirement funds and mutual funds, as well as individual stocks. Common reasons to not buy stocks/mutual funds are (1) stocks are complicated and I don’t know how to get started, and (2) stocks are too risky. Let’s review both of these drawbacks.
Stocks are Complicated
All too often, some of my friends and family are reluctant to purchase stocks because they do not understand the stock market. Even some of my most intelligent friends shy away from financial conversations that involve the stock market because they do not want to appear ignorant.
If you did not learn about investing in school or from your parents, how can you figure this out? How do you convert your dollars into stocks? How do you learn which stocks are worthwhile? Should you purchase individual stocks or mutual funds and, by the way, what exactly are mutual funds?
Investment Clubs Help You Buy Stocks
You can learn about many of these topics in a fun way by forming an investment club with like-minded friends and/or family. Since 2004, I have been a member of Take Stock, a ladies’ investment club. Our club is one of the 4,000 investment clubs of the National Association of Investors Corp. (NAIC). The NAIC was formed in 1951 as a 501(c)(3) nonprofit organization with the aim of teaching individuals how to become successful long-term investors. Originally, the NAIC’s focus was investing in common stocks, but, with the popularity of 401(k)s and other retirement plans, the NAIC has added education about stock and bond mutual funds.
The NAIC (also more recently known as Better Investing) stresses four principles for successful, long-term investing:
- Invest regularly, regardless of market conditions;
- Reinvest all earnings;
- Invest in growth companies (and growth mutual funds); and
- Diversify to reduce risk.
What Information Can I Get from NAIC/BI?
NAIC/Better Investing (NAIC/BI) provides many tools and resources to help individuals as well as investment clubs learn about investing. There is a stock selection guide (SSG) that organizes companies’ performance information to allow you to determine for yourself whether a particular company is a stock you want to purchase and the price is reasonable. Some of the free resources offered by NAIC/BI include:
- Over 100 free stock investing videos;
- An introduction to stock investing that explains the SSG;
- How to start your own investment club;
- Investor education articles;
- Stories from members; and
- 90-day free membership.
How My Club Works
My club was formed in 1999. It is comprised of nine women who meet monthly in each other’s homes. Of the nine members, the one with the longest tenure is a charter member and the most recent arrival has been in our club for just over one year. During our meetings, we review our club’s portfolio (currently stocks of twelve companies), discuss stocks to research for possible future purchase, and vote on any companies that we have already researched. It is not required that you meet in members’ homes—you could choose to meet at your local library, a restaurant, etc. We typically meet in the evening on the second Tuesday of each month and the hostess for that month provides a light meal. Every July, we meet at a local park for a summer concert and we bring our families/friends.
Monthly “dues” are used to invest in stocks and your ownership is based upon what percentage of the total portfolio you have invested through your paid dues. The monthly dues are in multiples of $25 (i.e., $25, $50, $75 etc.) and there is a monthly minimum of $25.
I highly recommend forming or joining an investment club. You’ll have the opportunity to learn more about the stock market, to learn more about individual companies that you and your club research, and you’ll get to know your friends and acquaintances better. The best part is you’ll have fun while investing in your financial well-being and you will all become richer by enhancing your friendship.
One Final Caveat
If you are new to investing you will probably want to invest the portion of your money that you will not need in the near term, such as a down payment on a home you wish to purchase three or more years from now, your children’s education fund, or your retirement fund. Your rainy-day fund should be kept in more liquid investments that can be accessed quickly.
So now that you know you can have fun and learn about the stock market, you may still be reluctant to buy stocks due to the risk involved. Let’s review this objection to increasing your wealth. . .
Stocks Are Too Risky
One of the primary concerns about owning stocks is the risk inherent in these investments. What if I invest my money in the stock market and the stock market crashes as we have seen since Covid-19 or like we saw in 2008/2009? While it is true that declines of 15+% in your investment portfolio are not desirable, it is also true that in every case where the stock market has had a large decrease, the stock market more than made up for the declines in the months and years following the drop.
As of this writing (April 30, 2020), since the beginning of 2020, the Dow Jones Industrial Average (Dow) is down about 18% and the S&P 500 is down about 11%. While not good news, if you were invested in the market during 2019, you would still be ahead because the Dow rose more in 2019 than the current 2020 drop. (Dow added 22% and the S&P 500 added 28% during 2019).
We have likely heard the old adage: risk is reward. That is, the more reward that is sought, the more risk that must be taken. If you are desirous of the smallest risk possible, then you would probably choose to park your money in (for example) savings bonds or certificates of deposit which will guarantee you a reward albeit a small one. If you prefer more reward, then you will likely choose to invest some of your portfolio into the stock market. Let’s look at an example of how a specific risk tolerance manifests into investment growth.
Five years ago, assume you invested $1,000 with (1) small risk (investing in a certificate of deposit), (2) medium risk (investing in an S&P 500 mutual fund) or (3) high risk (investing in only one individual stock). Here are the results:
|CD: “low” risk||S&P 500: “medium” risk||American: “high” risk||Apple: “high” risk|
4.75-year return (through 12/31/19, 0pre-Covid)
Takeaways from this Exercise
Here are the key takeaways from this table.
- The lowest-risk investment provides a 7.7% return over five years. This is based on investing $1,000 over a period of five years at current CD rates of 1.5% per year. Note that while the original investment of $1,000 grows over the five years, it is growing less than the rate of inflation over the five years so you have “lost ground” by investing in a CD. Over this same five-year period, the Consumer Price Index rose by 8.9%, higher than the 7.7% earned in the CD; thus, your buying power is less since the cost of goods has risen by 8.9% while your investment grew at 7.7%.
- The medium-risk investment provides a much better return than low risk. You would have earned nearly 40% over the five-year period.
- The high-risk investment was defined as investing in only one single stock. As you can see, if you chose American Airlines for your one stock, you would have lost 70% of your investment. However, if you had chosen Apple as your one stock, you would have more than doubled your money and earned a 121% return over five years.
Keep in mind that the results above include the effects of the drop in the stock market from COVID-19. If we look instead at year end 2019 — before the effects of COVID-19 — we see returns of 7.3% (CD), 53% (S&P 500), -37% (AAL), and 138% (AAPL).
Your Risk Appetite
If your risk appetite is miniscule, then you would probably want to avoid the stock market altogether and put your money into certificates of deposit. This will not bring wealth to you but it will give you peace of mind. If you have more tolerance for risk, then investing in the stock market by diversifying your stocks is a much better way to accumulate wealth. As shown in the example above, it is possible to earn more from investing in high-growth stocks, but it is also virtually impossible to pick which individual stocks will generate above average future growth. The medium-risk option will usually provide much better returns over the long terms than will the low risk-option.
How I Built My Wealth
Stocks—primarily mutual funds with a variety of individual stocks—have contributed to my personal wealth accumulation. I recommend including stocks in your assets and joining or forming an investment club with friends and family can be a fun way to further your wealth. Good luck!
Kay Rahardjo, FCAS, MAAA is an actuary and risk management professional. She retired from The Hartford in 2014 from her role as Senior Vice President and Chief Operational Risk Officer. She developed and taught an operational risk management course at Columbia University.