The Biggest Investing Mistake You Need to Avoid
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The biggest, most expensive, investing mistake a lot of people are painfully making right now is staying completely away from stocks. Unless you are investing with a short time horizon for your portfolio - less than three years, for example - avoiding equities can cost you a lot of money in terms of lost opportunities. Unfortunately, this seems to be the case for many families nowadays.
USA Today reported last week:
A record $9.43 trillion — enough cash to buy 120 of the biggest companies in the Standard & Poor's 500-stock index — is now sitting in money market mutual funds, bank savings accounts and CDs, according to Crane Data.
All that money is almost certainly going to lose value versus inflation in the long term, especially at the current rock-bottom interest rates. While on the other hand, stocks of companies which produce valuable goods and services have a much better chance of delivering positive real returns over the following years.
The only explanation I can find for this unreasonable fear of stocks lies in the jittery economic scenario we have faced over the last years, combined with a complete lack of faith in Wall Street and its institutions. There are valid reasons to be concerned about the macro environment, but that still doesn´t mean you should avoid stocks completely.
In fact, economic uncertainty can be the best ally for investors when it comes to producing above average market returns. Think about it for a second: when was the best time to buy: when everyone was irrationally optimistic about the markets during the dot com bubble or in the deeply pessimistic times of the great recession in 2008/2009?
If history is any guide, the current negative sentiment about stocks should be interpreted as a bullish sign in terms of future returns for this kind of assets. There is still the matter of selecting the right investments, but that really isn´t as hard as some fearful investors seem to believe.
Sure, those who bought Facebook (NASDAQ: FB) when it went public in May of this year are currently suffering a 50% loss, and they don´t have many reasons to believe in a sharp recovery in the short term. But that trade can´t be considered a valid sample of what can be expected from the stock markets if you do things in a reasonable manner.
Buying the Facebook IPO meant paying more than 120 times earnings for shares of a company without a reliable business model. Saying you shouldn´t buy stocks because of what happened with Facebook is like claiming that people should not drive because a drunken teenager crashed his car against a tree while maneuvering at the speed of light and texting at the same time.
On the other hand, Apple (NASDAQ: AAPL) is still very close to historical highs after delivering mind blowing returns over the last years. You could have made more than 350% in shares of Apple over the last five years, including 70% in the last year alone.
And this is no high-risk little-known company; Apple is the biggest corporation in the world and has been a favorite name of many investors for a long time. As long as you invest with a healthy degree of diversification, the Apples of the world should more than compensate for the occasional Facebook-like fiasco.
For investors concerned about company specific risk, ETFs provide a valuable tool to achieve diversification in a simple and cost effective manner. It is true that the S&P 500 index is still below its 2007 levels on a pure price basis, but that can be a very misleading statistic. First of all, the index is at historical highs on a total return basis – including dividends - an issue which many commentators usually ignore in their analysis, producing a serious miss presentation of historical data.
Besides, evaluating returns based on a lump sum purchase in a bad moment is not an objective analysis at all. Investors in their saving period should regularly purchase stocks at different points of time, which increases returns due to the mathematical benefits of buying more stocks at low prices. If you make recurrent cash contributions to your portfolio, on a monthly basis for example, you are getting more stocks for the same amount of money when prices are low, which can be a powerful tool to increase returns.
To sum up, an investor who invested in shares of the S&P Depository Receipts (NYSEMKT: SPY) ETF – which replicates the S&P 500 index – and made regular contributions to the position, as well as reinvesting dividends, would have done much better than what a simple observation of the ETF price chart may indicate.
ETFs have materially widened the amount of choices available for investors, with some instruments offering exposure to a select group of high quality stocks. Vanguard Dividend Appreciation (NYSEMKT: VIG), for example, focuses on companies which have been able to raise their dividends for 10 consecutive years at least, with several of them carrying a much longer track record of increasing dividend payments.
Companies like Coca-Cola, IBM and Exxon are included among the holdings of this ETF, and these kind of rock-solid businesses offer a considerably high probability of delivering positive returns over time. They can go unscratched through the business cycle, delivering solid financial results and raising their dividends in good and bad economic times.
If even VIG sounds too risky for you, a more defensive alternative could be Consumer Staples Select. (NYSEMKT: XLP) which holds consumer staples companies like Procter & Gamble, Wal-Mart and CVS. These corporations sell everyday necessities, so they would hardly be in any danger even under the most worrisome economic crisis. They may not be the most exciting high growth businesses around, but they still look much better than those CDs which are yielding almost zero.
In many areas of life, the most regrettable mistakes are usually made out of excessive fear, and the extreme stock avoiding posture of many investors seems to signal such is currently the case when it comes to portfolio decisions for many families. Ironically enough, not investing in stocks may be the biggest investing mistake you can make over the long term.
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acardenal owns shares of Apple. The Motley Fool owns shares of Apple, Facebook, International Business Machines, The Coca-Cola Company, and ExxonMobil. Motley Fool newsletter services recommend Apple, Facebook, The Coca-Cola Company, and The Procter & Gamble Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.