Being Smart with $$ - Letter to Clients and Friends: Fundamental reasons to be a stock-market investor despite the chaosBeing Smart with

Dear Clients and Friends:

It has been a tough year to be a stock market investor.  Therefore, I believe it is a good time to discuss the mechanics of the stock market and why the majority of experts believe that stocks are appropriate for most portfolios.  Forgive me if I make this too simplistic but a reminder of how we benefit from being an investor in stocks may be useful for everyone.

First, a quick reminder of stock market performance over periods we consider to be the worst of times.  I will reference the Dow Jones Industrial Average as the benchmark that the news channels seem to favor:

The Dow peaked in 2007 at 14,165.

It hit a low of 6,443 in 2009.

Today it is at approximately 22,400, almost 50% above its peak from before the crash 10 years ago despite being down almost 20% from its recent peak in October of this year.

 In 1987, the Dow reached 2,722.

On Black Monday October 19, 1987 it fell to 1739. 

Ten years later the Dow closed the year 1997 at 7,908, almost 3 times higher than the pre-crash peak. 

As a reminder, today the Dow is near 22,400. 

It should be noted that on top of price gains, some stockholders also received dividends each year. 

Now for stock market fundamentals:

When you buy stocks, you are an owner of the company.  As an owner, you share in the profits or losses of that company.  Profits are sometimes paid out in annual dividends so that even in the absence of a change in the stock price, you still might have a positive return.

America’s companies are quite profitable on average. Fortune.com reports that Fortune 500 companies as a group generated around $1 TRILLION in profits last year.  If the same occurs over the next 10 years, that might be $10 TRILLION in new value created that benefits the shareholders in these companies. Profits could be worse so you may prefer to assume they’ll generate $5-7 TRILLION.  When we hear that earnings will be poor in the future, don’t take that to mean corporate America will lose money.  It usually means that earnings might just be lower even though they will still be substantial. Even in 2008, an historically horrible year for the economy, Fortune 500 companies made a small profit.  And even though one year was quite bad, the years before and after saw far higher profits for these companies.

Stock prices can swing wildly for a variety of rational and irrational reasons.  But what happens over the next 10 years when $5-10 trillion of new profits are generated by these 500 companies which were recently worth approximately $21.6 trillion in market capitalization.  It might be reasonable to believe that the owners of these companies, the stockholders, will enjoy nice returns on their investments.

Is there a guarantee that stock prices will rise? Never.

Should you be invested in stocks if you need the money in the next few years?  Probably not since it can take a long cycle for the price of a stock to reflect the fundamental value of a company.

Should you be diversified? Certainly yes because while corporate America as a group is profitable, there will always be a few companies that don’t survive.  Add international exposure for even better diversification.

Are stocks right for everyone?  They are right for you for a portion of your portfolio if you have a long-term time horizon.  If you are retiring tomorrow, you will likely be drawing from your portfolio over the next 30 years and may benefit by having some of your money in the stock market.  If you are in your 80s and don’t expect ever to need a chunk of your money, you may want long-term growth for assets that will go to your kids.  Every investor’s needs are different and the appropriate allocation to stocks will vary for everyone.

Will you panic and bail out in tough times? If yes, stocks are probably not right for you as patience is how stock investors usually succeed.

Can you time the market and know when to get out and when to get in?  Research suggests that more people fail at this strategy than succeed.

I repeat that there are no guarantees in investing and past results may not be an indicator as to what to expect in the future. But consider this:  if you are able to earn an extra 2% on your investments, you might collect nearly double the money over 20 years. Avoiding assets that are volatile in the short term but usually offer higher long-term returns may be assuring yourself returns that don’t let you achieve your long-term goals.

As always, I am happy to discuss your individual circumstances in greater detail.

Larry Pike, CFA

Client Priority Financial Advisors LLC
www.clientpriority.com