Do You Have Enough Stock In Your Financial Diet?
By Richard P. Halverson

There is a simple fact that is true for the majority of people. People need to be building wealth for the future and stocks should be part of that program. Beyond what it takes to meet current living expenses people need to be saving and investing for the future. In nearly all cases stocks should be part of any long-term investment plan.

We have recently experienced a difficult bear market. Many people want nothing to do with stocks right now. This is a good time to be reminded that owning stocks for the long-term is a good idea.

There are a number of types of assets people can invest in. Among these assets stocks are frequently superior. Stocks are easy to use and over the years stocks have been a powerful source of wealth creation. Here are some of the most important asset classes available for investment. These assets can be roughly divided into paper assets and physical assets.

Paper Assets

·         Savings accounts, money market funds, and savings certificates with financial institutions.
·         Fixed income securities including U.S. Treasury, municipal, and corporate bonds.
·         Common stock.
·         Trading assets including commodities, options, and futures.

Physical Assets

·         Real estate including homes, rental property, land, real estate partnerships.
·         Hard assets including gold, and jewels.
·         Collectibles including coins, paintings, and antiques.
·         Business ownership.

There are various ways of investing in these assets. Some are very convenient and can be purchased through regular contributions. Others require special access to the market through licensed agents.

These assets can be held in various types of accounts. Such things as personal savings accounts, IRA’s, 401k’s, etc. Different types of account exist largely because of tax and regulatory laws. Sometimes people confuse the account type with the asset class.

The various types of investment assets, the numerous ways of purchasing them and the variety of types of investment accounts they may be held in makes the whole subject of investing for the future daunting for many normal people. Nevertheless, the future will get here whether you invest or not.

MOST PEOPLE SHOULD OWN SOME STOCK!

STOCKS ARE THE KEY SOURCE OF WEALTH CREATION IN A CAPITALIST ECONOMY. The value of common stocks is directly connected to the growth of the United States and the World economies. If these grow, stocks will rise. No other asset class captures this long-term economic growth as well. A long treatise could be inserted on how and why common stocks must grow with the free world’s economy but it would be of interest only to closet economists. The short story is that growing free economies require equity investment capital and that capital must be rewarded.

In the past 80 years the United States has endured wars, depressions, droughts, speculations, irrationally exuberant bull markets, equally irrationally despondent bear markets and numerous other forms of pestilence and plague and through it all common stocks have provided long term returns of right around 9%. Few other asset classes have performed so well.   Long term bonds, for example, have only done about 6%. This is important! Anyone familiar with the effects of compounding will realize this difference is enormous over time. For example, a 20 year old starting today and investing 10% of her salary in stocks for the next 45 years will probably have roughly $2,400,000 at age 65 compared to about $1,000,000 if she had invested in bonds. (Before taxes, of course, which takes some of the fun out of it.) That will really look good in 2048.

A key question for an investor to ask, therefore, is, “Am I optimistic about the long term future?”

Every reader will need to make up her/his mind on this subject, but I would like to offer a caution to Mormons. It has been my observation that many Mormons can become very gloomy about the future. I think this comes from an understanding that we live in the latter-days and that terrible events are prophesied. Additionally, it is easy to lose hope when we see the apparent collapse of moral standards all around us. While these things are true, none of us know when the end will be. Consequently the wise course is to:

·         Live your life spiritually as though the Savior is coming tomorrow.

·         Live your life temporally as though He is not coming in your lifetime.

Spiritually: this means keeping the commandments and following the prophet. Temporally: this means getting an education, establishing a career, having a family, being optimistic and building for the future by managing your finances for the long haul. Oh, and following the prophet. I have never heard President Hinckley recommend common stocks. But I have heard him counsel us to live within our means and save for the future. I believe common stocks should be part of that savings plan.

There are other assets that will appreciate with the growth of the economy. Real estate will, for example. But over time, no other asset is more fundamentally tied to the growth of the economy than stocks.

STOCKS ARE USER FRIENDLY . Stocks are easy to buy and sell. Accounts are easy to open; trades can be made with a phone call or on-line. In many cases, regular investments can be made through payroll deduction. The financial institution will provide regular statements of account activity. Stocks can be used in all the popular types of accounts such as 401k’s, IRA’s and regular investment accounts with banks and brokerage houses. There are assets like money market securities and bonds that are just as user friendly but these do not offer substantial wealth building potential.

STOCKS ARE EASILY STORED. Ownership of stock is evidenced by a certificate. This is true of all paper assets. In most cases, investors leave the certificate on deposit with the financial institution. If you choose to take physical possession of the certificates, they are easily stored and if destroyed can be replaced. None of these characteristics are true for physical assets ranging from real estate to gold. Ease of storage translates to low cost of storage. With stocks the cost is virtually nothing. With many hard assets the cost of storing the asset can exceed its wealth building potential.

TRANSACTION COSTS ARE LOW. There are commissions and other costs normally associated with the purchase of any asset. Competition and electronic efficiencies have driven commission costs down to near negligible levels. Some paper assets are even lower but these are associated with assets that do not build wealth. Physical assets all carry substantial transaction costs somewhere in the final price.

STOCKS ARE EASILY VALUED. Most stocks trade actively on organized stock exchanges. This creates a value that can be accurately calculated. This is important for monitoring your net worth. It is also very important for tax calculations, gift giving, estate valuations, etc.

STOCKS ARE EASILY LIQUIDATED. If there is a need to raise cash, stocks are easily sold and converted into cash. Sometimes even other paper assets are difficult to liquidate and physical assets can be very difficult.

STOCKS ARE PORTABLE. If you move, it is easy to take stocks with you. Some assets are so lacking in portability they may actually factor into an owner’s decision not to move.

STOCKS REQUIRE ONLY MODERATE SWEAT EQUITY. Allow me to define moderate. It is important to invest enough effort in learning about stocks that you understand what they are, why they make money, what the risks are, and the basic differences between blue chips, emerging growth stocks and value stocks, for example. This should not feel like an intimidating task. Anyone with normal intelligence can master these concepts in a short time. Many people expend a lot more effort learning how to use their computers. Once you have these basic concepts in mind, you can select stock mutual funds that meet your objectives. This allows you to leave the specific stock selection tasks to professionals and you can basically forget about it.

If you have the interest, you can certainly turn your stock investing into a part or full time business and make all the stock selections yourself. Most people would rather not put in that much effort. There are assets that require even less effort. Again these are assets that offer very little wealth building potential. There are assets, even paper assets, that require extraordinary skill, understanding and constant attention. Rental properties, for example, are hard work and don’t even think of venturing into the commodities or futures markets unless you know exactly what you are doing.

STOCKS CAN BE EASILY DIVERSIFIED. A wise principle of investing is to diversify to avoid excessive risk exposure. By purchasing a portfolio of at least 30 or more stocks representing different industries, a portfolio can achieve substantial diversification. Diversification can also be achieved by purchasing shares in a single stock mutual fund that is itself broadly diversified. This is the most practical choice for the majority of investors.

STOCKS HAVE A LOW COST OF ENTRY. By this I mean it does not require a lot of money to begin investing or to make subsequent additions. Buying stock mutual funds does this best. Some funds will allow accounts to be opened for a few hundred dollars. If you feel you do not want mutual funds and insist on buying and selling yourself, the cost of entry is much higher. It is difficult to have a properly diversified portfolio for less than $300,000.

STOCKS OFFER SOME TAX ADVANTAGES. You do not frequently hear the tax advantages of stock being touted but there are some. Over time stocks, hopefully, rise in value. When they are sold at a profit, they generate capital gains. Stocks held longer than a year qualify as long term capital gains and are taxed well below regular income. Further, recent legislation lowered the tax rate on dividends to between 5% and 15% depending on your tax bracket.

MOST PEOPLE SHOULD OWN SOME STOCK … BUT!

Stocks should be part of the long-term investment plan for most people. But they probably shouldn’t be 100% of that plan. The reason is that stocks do fluctuate in value. Sometimes, they fluctuate substantially. Bear markets, which is the only type of fluctuation that bothers people, can drag on for months or years. A person should not have everything in the stock market and then watch it plummet the year before retirement. Diversification of asset classes is important just like diversification among the stocks in the portfolio is important.

What percent of your net worth should be in stock a complicated question that I will not try to resolve here. Generally, there are three issues to be considered:

First, what is your time horizon? Your time horizon may be retirement, or this fall’s tuition. The longer your horizon the greater your exposure to stocks.

Second, what are your general financial circumstances? It can be awful to be strapped for day to day cash, then get laid off, only to see your stocks fall by 50%. (And those events are often related.) The more stable your situation, the greater your exposure to stocks.

Third, what is your personal tolerance for risk? Some people become very nervous with every market fluctuation. The higher your tolerance for risk the greater your exposure to stocks.

Many people are still reeling from the recent destructive bear market in stocks. In fact, the number of people who believe we are still in a terrible stock market environment surprises me. They seem to be unaware that the stock market is up 25% to 50% since the market bottom last fall, depending on the index you use to measure. Many of these people are waiting for the picture to clarify before investing in stocks. But trust me, the picture will never be completely clear. And if it seems there are no worries that is the time to really worry. In the meantime, the wise course for most investors is to make steady contributions to stocks during the ups and downs. Over the long term stocks will serve them well.