You Actually Invest In The Dow?
I received questions from last week’s article with some people confused about why I purchase the overall market as part of my wealth building strategy. Why not just ONLY stick with undervalued stocks and create my own diversified portfolio?
First of all, let me get this out of the way. The general stock market has negative connotation for people such as it’s artificially inflated, paper assets, and manipulated by corporations and the Fed. The truth is I understand all of these concerns, but it doesn’t change the fact that overtime stocks are a great way to invest your money and see compounded growth years down the line. As for it being a paper asset; owning stocks is being a shareholder of a business. Businesses are inflation proof for the most part because when prices rise, businesses are the first to be able to charge more and make up the difference which translates into higher stock prices. If one day the world ends and stocks crash, the truth is you will probably have more worries in other areas than you would with your investment accounts.
The inquiry as to why I even bother with the general market at all is a valid concern and one that I face when I’m making my asset purchases each month. The reality is that the majority of my investments in regards to the stock market is in individual companies that I like that have a great long-term outlook for the years to come. The general market is what I like to allocate a smaller portion of my savings towards for a diversified investment that is able to withstand the unforeseen turmoil one individual company might pose to my portfolio if it was a significant enough of a position.
The truth is, I see the general market as less of a risk because of the greater diversity you get when purchasing a basket of mainstream stocks. My main concern when purchasing a great deal of stock in just one company, is the risk of a disastrous lawsuit or catastrophic event that slams a stock into the ground such as the BP oil spill or a sticky gas pedal issue like Toyota dealt with just a couple years ago which could have gone much worse for them. At a certain point, you don’t want to put all your eggs in one basket and be extremely exposed in an event out of the ordinary. Even though I feel safe and get way more excited about purchasing undervalued stocks that pay dividends, I take a portion of what I would be putting towards stocks and put it towards the general market to take advantage of historical growth that is likely to play out over the course of the next 25-40 years.
The other reason I like to invest in the general market such a the Dow and S&P is that these indices have basic standards by which companies will be taken out when they under-perform and fall below certain criteria. It is geared to grow with selecting large companies that are meeting minimal expectations.
Investing in the general market is not an absolute necessity if you diversify across a large number of companies. It allows you to have exposure to the over the top winners but also exposure to the losers which typically puts you somewhere in the middle. My suggestion if you don’t want to purchase the broad market is look at at least 15 different companies to invest in and never put more than 4% of your entire net worth into a certain stock as your initial investment. At some point this company might outperform and grow to be a larger portion of your net worth than 4% which is absolutely fine. But beware of putting too much of your money in one specific investment such as a stock right from the get go. Creating your own diversified portfolio is a great way to side step a general index and purchase something that is protected from a one unforeseen occurrence that might hit a certain stock.
This Information Should Excite Anyone That Reads It
What is historically the best performing assets of all time? Jeremy Siegel, a professor of finance at the University of Pennsylvania, did some research and has lined up the results of $1 dollar invested across four popular investment vehicles from 1802 to 2006.
Results as follows for $1 invested in each class:
Obviously stocks were the clear winner and by a long shot I might add. To be exact, that is right about 700 times more than its runner up. Of course, the reality is that people don’t live for 200 years and this sort of expectation is unrealistic because of the time span but the principles on what to be investing in has not changed.
More research was done analyzing a shorter, more realistic time span and the results were pretty exciting as well. Siegel, in his book The Future for Investors, studied the returns of 50 of the largest companies in existence in the year 1950. Of these 50 companies, the ones with the highest returns by the end of 2003 were Kraft Foods, R.J. Reynolds Tobacco, ExxonMobil, and Coca-Cola.
If you invested $1,000 in each of these companies in 1950, reinvested your dividends, and didn’t touch them until 2003, you ended up with a:
That means you turned a $4,000 investment into $6,291,510 by buying four stocks and DOING NOTHING for 57 years.
Serious returns for some great companies. Now, if you were to have invested that $4,000 in the broad market, you would have ended up with $1,118,936 at the end of 2003.
This is five and a half times less than investing in those undervalued companies which is revelatory for why it’s important to pick the right companies and what will happen if you do. By investing in the general market you are trading maximum return potential for a more safe, more guaranteed nest egg many years down the line. I think this is an important supplement to someone’s future who sees the bigger picture to invest across multiple venues which is why a portion of my portfolio goes into the general market when I feel it is a good time to buy.
My advise for those like me who are investing with over 20 years ahead of them is to invest in both.
Be sure you are getting the right investment information from trusted sources that give you the edge you need to make your $1,000 dollars look astronomical years down the line.
To Your Success,
Editor at CrushTheStreet.com
You can contact me when questions or comments at firstname.lastname@example.org