Asset Classes: Common Stocks

Given that debt holders generally enjoy priority over equity holders, equity is higher risk and, therefore, over the long-term, is rewarded with higher returns than debt. Investment in stocks is one of the most widely used strategies for building high-return investment portfolios. When we talk about “equities” in this article, we refer to stocks in publicly listed companies, not equity in private corporations.

The array of possibilities for equity investments is truly dazzling. There are thousands of equities in publicly listed companies all over the world, with various levels of risk, some that pay out generous levels of dividends, others that pay no dividends, often companies that reinvest their earnings into growth. In general, stock prices are volatile and may rise or fall dramatically. We emphasize again: investment in stocks carries risk.

Over virtually any long-term time horizon, a diversified portfolio of equities generally brings excellent returns. One would have seen spectacular returns in the Dow Jones Industrial Average or Standard & Poor’s 500 if one had invested in one or the other index since 1989.

It should also be emphasized that if one purchases near a peak prior to a recession or depression, for example before the dot-com bubble or the 2008 financial crisis, one might experience quite a fall in value and need to wait for quite a few years just to recoup the initial investment.

Some investors deal with this by investing a constant amount per year, rain or shine. Others try to determine whether they are buying on a dip that will recover relatively soon, or “catching a falling knife”, e.g. a stock that will continue to fall, perhaps bloodying you in the process.

As Baron de Rothschild famously said, “buy when there is blood in the streets, even if the blood is your own.” Warren Buffet warned: “You pay a high price […] for a cheery consensus.” These thoughts constitute the essence of contrarian investing.

Bull Market

According to Goldman Sachs, the current ten-year trailing annual return for the S&P 500 of 15% ranks in the 94th percentile of all ten-year periods going all the way back to 1880. In terms of the best performance sectors, consumer discretionary and information technology significantly outperformed other sectors and the S&P500 for the last ten years.

The United States still dominates global stock markets in terms of trading volumes, number of listed shares, even equity returns over the last years.

Besides building a stock portfolio for themselves, investors may use Exchange-Traded Funds (ETF’s) to establish a low-cost, well-diversified portfolio of stocks. ETFs allow investors to gain portfolio exposure to specific sectors, industries, or countries even if investors do not have expertise in those areas.

ETF’s may also be leveraged. For example, a 3X fund means that the amplitude of both the upside and downside variations is multiplied by a factor of three. This is achieved by leveraging the ETF portfolio.

As the saying goes, past performance is no guarantee of future performance. After a ten year bull market, investing in equity warrants extra caution (e.g. consider reducing or eliminating leverage, investing in less risky assets, hedging with gold, etc.) Nevertheless, equities still have their place in any balanced portfolio.

Disclaimer: This article is intended for informational purposes only, and should not be relied upon for investment advice. It is important to do your own investigation and analysis before making any investments based on your own personal circumstances.

Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.