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Why the Stock Market Is Not As Risky as People Think
The Truth About "Safe" Investing
Before we can understand the relative risk of investing in stocks, we must first understand the alternatives enough to make the comparison. When many Americans think of a "safe place" to let their money grow, savings accounts and bonds (specifically U.S. Treasury Bonds) typically come to mind. While most understand that these methods will not grow their funds excessively fast, they fail to realize that there is a huge risk! In fact, it is almost certain that an investor will actually lose worth with savings accounts or short-term bonds!
According to Bloomberg, these are the current yields on United States Treasury Bonds.
United States Treasury Bonds
The current savings account yields have a huge range. They can pay out anywhere from .01% - 1.00%, but the 1% side of the spectrum is almost unheard of (even in high requirement money market accounts). For instance, my primary bank offers savings rates starting at .20% and going as high as .45%. However, to get that higher rate of .45%, members must have a balance of $250,000.00 in that account at all times!
While there are a tremendous amount of variables to consider here (compound frequency, ability to sell on the secondary market, funds availability, etc.), it is still simple to see that these methods of saving/investing do not offer much return! However, when inflation is factored in, what may look like a simple small growth opportunity, can actually become an consistent loss! Currently, the average yearly inflation rate in The United States is about 2%, meaning the average savings account member is actually losing worth! Even if a smart investor gets a savings account with all of the right options to help battle inflation, or builds a secure Bond/CD ladder to actually accrue some gain, there are much faster and efficient ways to achieve this growth!
What is your annual yield for your savings account?
While it is no secret that purchasing shares in a company do carry some risk, all investing is a gamble to some extent. Even social security is a bet on whether or not an individual will live to claim what they have paid in! However, in my opinion purchasing stocks can be extremely rewarding for the relatively low risk that investors take with proper execution. To be successful in this endeavor, research means everything. Research the strategy, research the company, research the market, research market trends, research the politics of the economy, and after that, go ahead and research "research". Jokes aside, if an individual does not feel safe when deciding to buy stock in a company, one of 4 things is usually happening:
- The stock is bad or at a bad time to buy (currently).
- The price is higher than what the investor feels comfortable parting with.
- The investor has not done enough research.
The purpose of this article is not to hand out a list of stocks to buy (based on my research), or even a step-by-step guide to choosing the right stocks. The hope is to illustrate how investments in the stock market have the potential to be arguably safer than more common investments.
When it comes to investment types and strategies, the choices are endless. From futures trading, to options, it can get confusing picking the best route for yourself. But, in my opinion, when it comes to safety, consistency, and simplicity dividend stocks reign king; and when it comes to dividend stocks Johnson & Johnson (JNJ) is constantly a top performer.
Traditionally, people tend to purchase stocks for either the growth potential (the potential for the stock to be worth more later) or the dividends. Simply put, dividends are profits shared with investors. The company uses the cash flow from the sold shares to make more money, and kicks some back to those who purchased shares to reward them and make the company more enticing to future investors. These payments can be paid monthly, quarterly, semi-annually, and annually (which determines the potential to profit from compounding). There is a large group of individuals who have made their fortunes from choosing stocks based around the amount, frequency, consistency, and growth of the dividend payments.
To get a better understanding of the simplicity of buying dividend paying stocks rather than stocks purchased for growth, let's take a look at the price fluctuation over the last 20 years.
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Even though there is a clearly visible upward trend in Johnson & Johnson's stock prices, timing the market is very difficult; even to those with an abundance of time and flexibility. Buying and selling when the "almighty line" is not at the right place, could be catastrophic, and paying others to make those investment decisions usually costs money!
Now let us see how much JNJ paid to it's shareholders in dividends over the same period of time.
Instantly, two things become obvious. Johnson & Johnson has been paying it's shareholders dividends consistently for a long time and those payouts continue to grow! To be even more precise, JNJ's dividends have been getting larger for over 50 years!
But let's get back to the 20 year comparisons. In this table you can truly see how strong and consistent the dividend growth has been.
The best part is that Johnson & Johnson does not stand alone in this prestigious tier of dividend gods. With that whole "research thing" I discussed earlier, one can easily find enough of these companies to properly balance out a portfolio! Things to consider when choosing these stocks are:
- Industry/Sector security
- Company age
- Company financials
- Dividend history (frequency, growth rate, yield %, etc.)
But most importantly, what it comes down to is the ability to find companies with a long history of increasing dividends and the ability to sustain those increases.
What Exactly Are the Risks?
There is always the possibility that an investor could lose every penny that they put to work, however, when choosing a high quality dividend stock such as Johnson & Johnson, there are really only a few likely scenarios where the potential to go bust exists. Assuming all dividends are reinvested for stronger compounding, the most likely financial loses would come from:
- The company going broke. (Although this is not likely when picking companies with long and strong histories.)
- The investor selling too early. (This is definitely a long-term strategy. Beware of stocks with outrageously high yields, as there may be a good reason. Also, those type of dividend payments are not usually sustainable.)
- The dividend growth slowing, stopping, or shrinking. (This is also unlikely for the same reason as number 1. If a stock's dividends start to fluctuate in the wrong direction, analyzing the changes should be considered in terms of risk assessment and return on initial investment.)
Although there is no perfect investing solution for everybody, I personally love the concept of investing in the top dividend paying stocks. I also, don't worry too much about losing my investments, even though I must admit that I check in on them very frequently as it can be very rewarding and interesting. If you plan to follow a similar path, I would strongly advise diversification; concerning avenues of investment, as well as which dividend paying stocks are in your portfolio. In case I haven't mentioned it enough, research is key. But I find that research isn't much of a chore when it comes to how I can make my money work for me the hardest!