Allworth co-founder Scott Hanson shares a few key reminders about stocks.
In this space a couple of weeks ago I wrote about bonds and their role in a portfolio as, among other things, a hedge against the volatility of stocks.
This week, just for perspective, I thought I’d turn the tables and write about some of the advantages and nuances of stocks.
Simply, what are they and why are they almost certainly a key component of your investment portfolio?
First, a stock is a share in the ownership of a company. It represents a claim on a company’s assets and even its earnings. The more of a particular stock you buy, the larger your stake in the firm.
When it comes to investing and references to stock, the words “shares” and “equities” are often used, as well. Technically, however, “share” is a more specific term than stock. A share is a unit of ownership in a particular company or of a certain financial instrument, while “stock” can be more generic and might be used to refer to a collection of holdings in a portfolio.
In this light, you could say, “All my money is tied up in stock.” That could mean you own parts of dozens of companies. Whereas when you use the term “share,” you might say, “I own one share of stock in the ACME Corporation.”
So, why are stocks an essential investment in most portfolios?
One main reason is that throughout its history the stock market has created untold amounts of wealth. (The S&P 500 has returned an average of between 8% and 12% annually since its inception in 1923.1)
But, despite those average yearly gains, the S&P, and other indices, obviously don’t go up every year. (For example, historically, the S&P has suffered a year-over-year loss 30% of the time.1)
Aside the fact that stocks offer the potential for excellent returns, another key reason people invest in them is to protect their money from inflation. Case in point, in the last 100 years, inflation has run about 3% per year, but over that same period, the average return on stocks has been almost four times that amount.2
Which is why - outside of an emergency fund, along with money for daily expenses - that most people should resist any temptation to keep their money sitting in cash. Take 2021 and its 7% inflation. If you had $1 million sitting in cash, year-over-year, you lost $70,000 of purchasing power. Simply, if fear keeps you out of the market, and you keep your money in cash, even in low inflationary periods, your money is still losing value every year.
Next, stocks are also a popular investment because, in certain circumstance, they can provide passive income. Consider dividends. While it’s true that not every company you invest in offers them, some do pay their shareholders either a monthly or a quarterly payout.
Another fact that makes stocks such a popular investment is that most are publicly traded on a major exchange (NYSE, Nasdaq, Hong Kong Stock Exchange, etc.). This makes them a more liquid investment (easier to buy and sell) when compared to things like real estate, debt instruments, and art.
And lastly, it’s likely that you own stocks for their ease of diversification. If you’re a regular listener to our podcasts, you’ve no doubt heard us talk about the importance of a well-diversified portfolio. Owning stock not only makes it easier to diversify your risk among various stocks, but they also serve to balance your portfolio opposite other types of investments such as bonds and real estate.
Just as a reminder, the information in this article is for educational purposes only and should not be construed as financial advice. Always remember that every investment carries risk, so I urge you to speak with your fiduciary advisor before investing in stocks or in any other vehicle.
Allworth Financial is an education-based, fiduciary advisor, which means that we believe that the more you understand about investing, saving, and finance, the better your decisions about money will be. If you aren’t already a client of Allworth, whether you just want an unbiased second opinion, or even if you’ve never worked with an advisor before, I encourage you to make an appointment with one of our fiduciary advisors for a complimentary, no hassle assessment of your investments and overall financial situation.
2 U.S. Inflation Rate by Year: 1929 to 2024 (investopedia.com)