Stock market volatile, but remains important investment option

September 1, 2011

“I hate the stock market.&rdqou; That was the subject line in a lengthy email I received yesterday from an old friend. The body of the message was equally firm.

“I hate the stock market.” That was the subject line in a lengthy email I received yesterday from an old friend. The body of the message was equally firm. Here’s more of what the writer had to say:

“I’m liquidating all of my stock market investments. I simply can’t tolerate the volatility, the irrational and unpredictable behavior of the market, the risk of another worse-than-ever meltdown, and the behind-the-scenes manipulations by the major financial firms and insiders. As often as not, good financial news results in a ‘down’ day for the market while disappointing financial news produces an ‘up’ day. I’ve had it. From now on, I’m investing only in U.S. Treasuries and bank CDs.”

And he wasn’t finished.

“In a single day, I received three mail promotions for three of those ubiquitous newsletters guaranteed to make me rich. The first cautioned in screaming headlines that runaway inflation was an absolute certainty and only by subscribing to that newsletter could I expect to learn the secrets of survival when the dollar becomes nearly worthless.”

He went on: “In the second, I was told that while the overall stock market would enjoy modest gains over the next two years, for only $99 per year I could subscribe to a newsletter that would let me know about specific stocks that were set for a spectacular rise in the very near future. Investing in those stocks would bring me returns that would far exceed those of the average investor.

“The third mailing warned that the coming financial Armageddon would see a stock market collapse that would make 1929 seem like a walk in the park. The only ‘safe’ investment, it proclaimed, was in precious metals such as gold and silver. Of course, it cautioned, there are several ways to invest in precious metals. Only through this newsletter could I learn of the ‘safe’ way to protect myself.”

‘Sane’ investments
As his final point, he wrote: “In my view, as long as the U.S government survives, Treasury securities and CDs from FDIC-insured banks are the only sane places to put your money.”

Those are rather extreme views, of course, but in some ways they do strike a nerve. There’s no escaping the unprecedented volatility of today’s stock market with triple digit gains and losses becoming rather common, and ups and downs in the market that seem to be random, with no underlying financial rationale. Still, history would suggest that this investor, provided he actually intends to follow through with his complete withdrawal from the stock market, would likely be making a big mistake.

Despite the unsettling behavior of the market these days, more than 100 years of history have taught us a few lessons, arguably the most important being that failing to allocate a significant portion of one’s portfolio to equity investments throws up a serious blockade on the road to financial security.

Prophets of doom making a living scaring people about the coming of financial doomsday have been around almost as long as the stock market itself. While they differ sharply over the exact nature of things to come, so far they have all been wrong. Since it’s impossible to predict the future, logic would suggest that we take a look at the past to see if it offers some investing guidance.

Stock market history
Consider the long-term performance of the stock market. According to the popular website Motley Fool, throughout stock market history over the past hundred years, the average yearly return including dividends for periods of 25 years or longer has been around 9-10 percent. Quite simply, there is no other form of investment with that kind of record.

What about more recent returns? The average annual stock market return for the past 25 calendar years was 11.2 percent (8.4 percent in appreciation plus 2.8 percent in dividends). To be sure, there have been many periods within these ranges where the market has done badly (1929, 2008 and others), but smart investing in the market means long-term investing.

To be sure, if you have a nest egg that you’ve been building to put a child through college in just a couple of years, putting it all in the stock market would hardly be the thing to do.

Common sense approach
Of course investing in the market requires a solid dose of common sense. Among the most widely accepted philosophies is the need for careful asset allocation. What percentage of your portfolio should be invested in stocks and what percentage should be in bonds and cash equivalents depends on such things as your risk tolerance, your age, your distance from retirement and other factors.

You must also consider what form your investments in equities should take. I agree with those professionals who suggest that the average investor is far better off sticking to mutual funds rather than wading through the thousands of individual stocks trying to zero in on the winners.

While the full-time pros who manage mutual funds are a long way from perfect, it stands to reason that they are more likely to enjoy a higher overall batting average than the lone part-time investor struggling to digest the massive statistical data being churned out in this information overload age.