By Guest Contributor Nancy Tengler.
Recently InvestingNerd released an investment literacy study finding that “many Americans avoid investing due to uncertainty or fear of losing money.” The operative word is fear. When faced with the unknown most of us opt for safety over potential total return.
Yet, if we think we are safely stashing our money in a bank money market fund we may be taking more risk than we know. Money market rates averaged 0.15% in 2012 – that is just fifteen cents for every one hundred dollars invested. Meanwhile, the Bureau of Labor Statistics reported that inflation rose 1.7% in 2012. So while Americans lost $1.70 in purchasing power for every $100.00 spent in 2012 they were earning–if invested in money market accounts–11 cents for every $100.00 saved. Hardly a winning or safe strategy.
Compare that with the return of the Dow Jones Industrial Average (DJIA) in 2012 of 10.24% or $10.24 for every dollar invested.
Investing is meant to provide future funds for future needs, which means that our investments have to, at least, provide returns above the rate of inflation.
Yes, but, you say. What about the huge losses the market suffered in 2007 and 2008? Declines of that magnitude are the source of fear. I get it. I was there, too. And the devastatingly speedy decline of the market was breathtaking. Yet, as with every bear market brawl, if you are a steady and careful investor, you can make an enormous of amount of money. If you adjust your time horizon to the long-term you can count on the long-term sustainability of the stock market.
Allow me to illustrate. Below is a chart measuring the five-year performance of one of my favorite high-quality, long-term holdings: Coca Cola (KO). KO is an industry leader with an iconic brand and great management team. It also doesn’t hurt that KO pays a dividend of $1.12 per share for a yield of 2.8%. The dividend serves as a nice cushion in declining or flat markets and guarantees a portion of investor total return well in excess of money market rates. Note that from the market bottom in early 2009 the stock has not only generated enviable returns but has outperformed the DJIA which has also generated returns well in excess of money market accounts and inflation.
If we take a longer-term perspective and look back to the mid-1960’s (the longest period available on Yahoo Finance) we can measure the stock’s returns over a period which includes a number of bear market periods and a number of periods when KO has been out of favor with investors. There are two important conclusions to draw from the chart: over the long-term the stock market (as measured by any index–in this case the DJIA) generates solid results and high-quality companies like KO will generate excellent returns over a long-term time horizon even when bear markets are included.
The temptation for investors is to become fearful in the face of bad news and falling stock prices, yet that is exactly when long-term investors should step up. Buying a little, then a little more (this is called dollar cost averaging) is a prudent strategy because we never know when a stock or the market have hit bottom until we begin to dig our way out. Never mind that you don’t have thousands of dollars to invest. The costs of stock trading are now low enough it is possible to buy one share at a time if need be.
Identify a list of great companies. The list should include names of products or services you consume. Watch the stock prices. And stay tuned. We will be discussing tools for selecting great companies in upcoming blog posts. Knowledge will reduce fear. And make you a great deal of money.
Note: Since 1900 the DJIA has returned on average approximately 9.4% per year.
Disclaimer: The views and recommendations in this piece are held by the individual contributor and do not necessarily reflect the opinions of NerdWallet as a whole.