Want to be a part owner of Microsoft? McDonald's? Google? JetBlue? Or maybe you'd prefer to own Disney or Whole Foods.
A good chunk of corporate America - and, in fact, much of the business world - is for sale every day through the public stock markets. Publicly held companies share their wealth with those who own "shares'' in their company by investing in their stock. When these companies succeed, so do their investors.
Conversely, of course, their investors fail when they do, too. And while most Americans understand and are willing to take that risk, many avoid investing in stocks altogether - or they sell their stocks at the first sign of trouble.
These days, of course, there are plenty of signs of trouble. Interest rates, oil prices, inflation, terrorism and the weak dollar are just some of the factors that are causing the stock market to be about as stable as a New Orleans levee.
The economy is not in a recession, but don't tell that to restaurant owners, retailers and others who are seeing consumers spend more slowly than they have in years. Many economists are predicting a recession, but the current economy may be in a period when everyone acts as though a recession is taking place, even though the economy is still growing (albeit slowly).
So, given the growing economic misery, should you sell your stocks or at least stop investing in the market until conditions improve?
The answer is, "It depends.''
Buy, don't sell
You can't time the market. Turn on the financial news at any time and you can hear plenty of market predictions. Sure, oil prices, inflation, interest rates and other factors are going to influence the price of stocks. But predicting with certainty that stock prices will rise or fall is like predicting with certainty that the Patriots will win the Super Bowl.
Too many factors can affect the outcome. While many factors point to 2008 to be a flat year at best for stocks, prices have already dropped for many stocks. Will the prices turn around during the next 10 months? Or will they continue to fall? No one knows for sure. Some people believe that because prices have fallen, there is a buying opportunity, while others believe that staying in cash for the time being is best.
International markets may also rebound. International economies in general are far less dependent on the U.S. economy than they have been in the past, yet in recent months, their performance has reflected that of U.S. stocks. Prices may adjust in months to come to better reflect their growing independence.
The operative word here is "may.'' Like predicting election results and the weather, even experts who make predictions for a living often get it wrong.
Inflation is back. With inflation up around 4 percent, your money is losing value unless you are getting returns on your investments that are higher than that.
The "real'' rate of return - calculated by subtracting the rate of inflation from the rate your investment earns - determines the buying power of your money. If your real returns are negative, you are not even breaking even. The value of your money is decreasing.
While past performance does not guarantee future results, historically stock is one investment that over time has earned returns that have outpaced inflation.
Investing requires a long-term perspective. Volatility can make any investor queasy, but the disciplined investor will take a long-term perspective.
On any given day - and in any given year - you may lose money on your investments in stock. In general, if you keep your money in stocks for a long enough period, there is a chance that long-term gains may exceed any short-term losses. So investors need to evaluate their time horizon when choosing to invest in stocks. The longer your time horizon, the greater the comfort level you may have with the percentage of investments in stocks.
Buy low and sell high. When stock prices do drop, consider thinking of it as a buying opportunity. Practically everyone has heard the expression "buy low, sell high," but for most investors it remains an expression, rather than an investment practice. Consider today's housing market. Housing prices have dropped, interest rates are low and there's plenty of inventory on the market. Yet few people are buying.
Investing when prices are low is like taking advantage of a sale. You can buy more for your money. Current stock prices are not at fire sale prices, but they are lower than they have been in recent years.
Adjust expectations
If you've decided to hold on to your stocks, or if you're investing in stocks for the first time, what can you do to control risk in case stock prices drop?
Diversify. It may make sense to invest some of your money in stocks, but don't invest it all in stocks. By keeping some of it in bonds and other investments, you can reduce your risk.
At any given time, some investments are likely to perform well and others are likely to perform poorly. Diversification spreads risk but does not eliminate it.
You can diversify by investing in small- and large-cap stocks, growth and value stocks, and international and domestic stocks. You may consider mid-cap stocks, emerging market stocks and other subsets as well.
Allocate and rebalance. Investors are typically advised to follow an asset allocation strategy, dividing their entire portfolio based on set percentages that reflect their tolerance for risk, investing timeline and financial goals.
Asset allocation requires rebalancing regularly to make it work long-term. As a simple example, assume that 75 percent of your investments are in stocks and 25 percent are in bonds. If, over time, stocks performed well and bonds did not, stocks may account for 80 percent or your portfolio or more.
Having that large of a percentage of your investments in stocks would put you at significant risk in case stock prices tumbled. Taking some of your profits from stocks and re-investing them in bonds is an example of rebalancing.
By rebalancing, you can not only maintain adequate diversification, you can also practice the principle of "buy low'' and "sell high.'' You will be able to buy more of the investment that is performing poorly than you would if you waited until it was performing well.
Dollar-cost average. Investing a set amount on a regular basis not only reinforces good savings habits, it also reduces risk. If you invest a large sum of money on one day, you run the risk that the market will implode the next day, reducing the value of your investment. If you invest the same amount regularly, which is known as dollar cost averaging, you will be spreading risk over a longer period of time. In the current environment of market volatility, this principle may be even more important.
Keep your expectations realistic. When you evaluate investments you can look at the total return. This is comprised of two elements. The first is the income generated (dividend and interest income). The second is appreciation if the investment gained value or depreciation if it lost value. Stock prices could be flat this year. But if they pay dividends, you may enjoy some return, even though there was no appreciation. If you keep your money in a savings account or a money market fund you may incur almost no risk, but interest rates are low, providing less reward.
Bonds, savings accounts and money market funds provide safety from loss of principal, but you sacrifice potential appreciation - and, during periods of low interest rates, such as we have now, income generated is lower than the rate of inflation. Stocks provide a potential hedge against inflation with the risk of loss of principal in down markets.
Having a balance between stocks and fixed income is the appropriate method to follow. How much of each depends on the factors discussed above.
Darrell J. Canby is president of Canby Financial Advisors LLP in Framingham. He can be reached at dcanby@canbyfinancial.com.
