4/2/2013 6:45 PM ET|
How to learn to love stocks again
After a five-year breakup, there are many signs average investors have a renewed love for stocks. Here's how to avoid getting burned again.
After breaking up with the stock market five years ago, Americans are taking some tentative steps toward reconciliation. Like a lot of troubled relationships, this one has been marked by accusations, recriminations, resentment -- and a lot of fighting over assets. What stocks did to investors in the bear market of 2007–09 isn't easily healed -- across-the-board losses of 50% and more are hard to forget and even harder to forgive. But at the start of 2013, it looked as though investors were ready to renew their vows.
Lou Horvath, a retail manager in Pembroke, Mass., is among those willing to give stocks another go. Horvath, 44, invested aggressively in stocks until the financial crisis cut his portfolio in half. "I pulled out and stayed out for three years," he says. But last fall, Horvath met Jeff Cutter, an adviser in Falmouth, Mass., who made him feel better about getting back into the market by recommending funds that aim to reduce volatility and risk by adjusting their exposure to stocks as their managers see fit. "I'd like to see how this goes, then reevaluate," says Horvath, who still has half of his assets in bonds and certificates of deposit.
Investors who can figure out how to forge a lasting relationship with stocks are likely to be rewarded in the long run. What's surprising is that people only now seem to be coming around to the notion. After all, from the bear market's bottom in March 2009 through Feb. 1, the Standard & Poor's 500 index ($INX) returned a sturdy 143% (or 26% annualized). And yet for most of the upswing many individual investors ignored the bull market. Others mistrusted it. And some didn't even realize it existed. Despite a 16% gain logged last year alone, nearly half of Americans surveyed in December by the Edward Jones brokerage firm thought that the market was down or flat in 2012.
Propelled by small progress on the nation's fiscal challenges and mostly encouraging economic signs here and abroad, the market surged 12% from mid-November through Feb. 1. That pushed the S&P 500 to just 3% below its record high of 1,565, set in October 2007, and caught people's attention. The index finally eclipsed that mark in late March.
Since the start of the year, investors have been pouring money into stock mutual funds. In January, stock funds took in $41 billion more than they lost, according to Strategic Insight, a fund-research firm. The figure represents the first positive monthly net inflows since April 2011.
Optimism is high. According to a recent survey by the American Association of Individual Investors, 48% of those polled said they were bullish on the stock market. That's well above the long-term average of 39%.
It remains to be seen, however, whether the wave of investors returning to stocks will become a groundswell. The start of the year is seasonally strong for mutual funds as investors seed retirement accounts, and $41 billion doesn't go nearly far enough to erase the $548 billion that came out of stock funds between 2008 and 2012. Moreover, the next economic calamity, here or abroad, could send investors running for the exits again.
Plenty of people, the recent rally notwithstanding, are still scared stockless. Matthew Hammer is emblematic of a generation smacked so badly at the start of their investing careers that they want nothing to do with stocks. For Hammer, 30, a post-doctoral computer science researcher at the University of Maryland in College Park, it's not just the stock market crash but also the attendant financial scandals that have colored his outlook. Says Hammer: "My cynicism goes deep. I think the financial industry is one big pyramid scheme -- or a series of related pyramid schemes. It's like a carnival where all the games are rigged. You're just going to get swindled if you try to participate." Hammer's money now goes into a checking account at his bank.
Older hands have lost faith, too. Ed Harrop, 64, recently retired from Johnson & Johnson (JNJ), is nostalgic for the days when investors had time to ponder portfolio decisions. "What drives investment decisions now is overwhelming to me, with the vast amounts of data you need to process and the speed with which computer trading and news announcements seem to move the market." Harrop, who has half of his investment assets in J&J stock, had intended to invest more actively upon retirement. "Now, it doesn't seem like fun," he says. "I'd be standing there with a whole bunch of VHS tapes in a CD world." Make that a digital world, where computer algorithms can storm the market in nanoseconds.
Rekindling an old flame
Holdouts like Harrop and Hammer will be hard to lure back into a market that can be mercurial, mysterious and sometimes flat-out badly behaved. Even so, there are good reasons for almost every investor to learn to love -- or at least live with -- stocks again.
One of the chief arguments for owning stocks is that your portfolio simply cannot be diversified without them. "By definition," says Ben Birken, a financial planner with Woodward Financial Advisors, in Chapel Hill, N.C., "a portfolio without stocks isn't well diversified. That would be like having only 500 out of 1,000 pieces and claiming that you still had a puzzle."
That's not to say that a diversified portfolio, which holds an array of assets, doesn't take its knocks in the market. When nearly all stock market sectors and most asset classes (except Treasury bonds) collapsed in 2008, many market watchers questioned whether diversification was still a relevant strategy. But over time, a diversified portfolio provides the best combination of reasonable returns with bearable volatility. Researchers at fund company T. Rowe Price compared the returns of portfolios that varied from 100% in bonds to 100% in stocks with various combinations of stocks, bonds and cash in between those extremes. From 1985 through 2012, a portfolio of 60% stocks, 30% bonds and 10% cash would have returned 9.8% annualized -- about 93% of the return of an all-stock portfolio, but with just 62% of the risk.
Many investors' portfolios today are lopsided in favor of bonds. The flight to safety was a good call during the bear market in stocks; but today, the risks in bonds are greater, and the values in stocks are better. For now, bondholders can expect to earn whatever they collect in interest, with little or no price appreciation -- which means returns in the low single digits. That compares with a likelihood of high single digits -- and possibly more -- from stocks. For income investors, dividend-paying stocks are an enticing alternative to bonds, with the 2.2% average yield on S&P 500 stocks eclipsing the 2.0% yield on 10-year Treasurys, and with many high-quality companies offering dividend yields well above the yields of their bonds.
Because interest rates have been on the down escalator for more than three decades, investors may be unprepared for the risk of higher rates (bond prices move in the opposite direction of interest rates). Bond market yields won't rise right away; the Federal Reserve has committed to keeping short-term interest rates, which it controls, low until the unemployment rate falls further, and it is trying to keep market rates down through its massive bond-buying program. But bond investors almost certainly will anticipate rate hikes before the Fed starts tightening. A rise in yield of less than a half-percentage point would reduce the return of a 10-year Treasury to zero over the course of a year.
More from Kiplinger's Personal Finance magazine:
VIDEO ON MSN MONEY
The Dow is at a record high, web sites like MSN are telling people to BUY, BUY, BUY - the economy has recovered, Facebook was supposed to be a sure thing, etc. When will you people (odd lotters) learn that Wall Street doesn't care about you and they will say anything (lie) that they have to in order to part you from your money. Just look at the price of commodity stocks (steel, aluminum, copper, etc.) - they are severely depressed right now. Essentially this means that there is a decreased demand for the raw materials from which all things are made; the reason being is that there is less demand for these metals because the economy HASN'T recovered. The statistics may say the economy has recovered but unfortunately you can't eat statistics.
This is just a basic fact of supply and demand.
QUOTE: "But at the start of 2013, it looked as though investors were ready to renew their vows."
"Vows?" Well, I guess buying stocks ARE a bit like taking marriage vows. In the first place one must make an intelligent selection: I like stocks which represent a necessary part of our economy. Energy, Transportation, Food; such areas MUST continue to exist else everything goes [in which case there is nothing left to worry about]. Dividend paying stocks are desirable for several reasons but mostly because short sellers usually stay away from them [they have to pay the dividend up front] and so they are not, usually, as speculative as others might be. In addition, I like to be in for the long haul: If one keeps getting a divorce whenever the market drops, only to return when things Improve, then you will lose a lot of money very quickly. Make good investments and stick to them.
Also -- if you've a mind to -- figure out just how much you are willing to lose and 'play around' just a bit with speculative stocks that seem to offer a tremendous profit... Just remember --- it's very risky.
While there are always opportunities to make money on the stock market and people will continue to do so, the stock market is a bubble that will at some point burst. You can't have more money in the stock market then there is printed, have record highs in the stock market and have values that are based on crazy arbitrary decisions about consumer confidence and not have a recipe for disaster.
A great example was a stock this last year (I apologize for not remembering the company) that's stock value dropped a significant amount because in their yearly earnings report they made more than the year before and more than they predicted, but as much as stock market experts thought they would. Think about that, the stock inflated because experts said it would do amazing even though the company predicted more conservative gains and when the company beats their prediction, the stock tanks.
Until the stock market is at least remotely based on the tangible world, there will always be risks to investing in it. It is best to take your money out while it is high, save as much as you can in no risk bonds and when the stock market tanks, get in on the ground level.
"Optimism is high. According to a recent survey by the American Association of Individual Investors, 48% of those polled said they were bullish on the stock market. That's well above the long-term average of 39%."
Yeah sure, optimism is high because the Fed Reserve continues to pump $85 billion buying our own debt with more debt ( faux money.) Keeping interest rates low on home loans with savings earning almost nothing hoping to drive savers into stocks. Faith and credit in in our currency is fading quickly as our creditors have shied away from our bonds
No thanks, rather invest in guns, ammo and survival essentials for the coming financial collapse from too much debt and out of control government spending.
If you buy the rock solid stocks like JNJ,EMR,ABT,VZ,T, you`ll never fall out of love
with stocks.Just buy VIG and be done.
Nothing today from my good friends "the short-sellers and gold buyers" at MSN MONEY: JUBAK, FLECKENSTEIN AND MIRHAYDARI ?????
MY OH MY.
If this market doesn't go down soon our three friends above are going to be in bankruptcy court. How can you be in such a high profile position and yet day after day after day be completely and utterly wrong about the direction of the stock market?? We will easily cross S&P1600 and maybe hit 1650 before we have a consolidation but the long term trend is one slow ride to the top. Anybody not in this market is literally throwing money away. Free money. Never bet against America. God bless Ben Bernanke and President Obama and his MIT-trained czars for saving the global stock market. GOP Congress: you are worthless. Go home, sit on the porch and go back to canning peaches and making moonshine because you have done nothing but damage our worldwide reputation. If this were Russia, Putin would have purged you from government for the huge mistakes you have made. Stay long and prosper.
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