Investing in stocks can be risky, but rewarding

When the stock market crashed in 2008, many investors in stocks lost more than 30 per cent of their investments. This year, stocks are down more than 10 per cent. The question many people have, then, is whether stocks are too risky. The answer is probably “no” — if you invest well.

Over the past several years, stocks have indeed been on a bumpy ride.

The benchmark Straits Times Index (STI) here rose 20 per cent from about 2,962 in January 2017 to 3,577 in April this year, then dropped about 14 per cent to 3,083 by mid-November.

Daily fluctuations in recent months have been large as well. Rises or falls of 1 per cent or more in a day have been common, as local developments and fluctuations in markets such as the United States or China affected stock prices here.

With such dramatic changes in the market, a fundamental question many investors have is whether to invest in stocks at all.

The key reason savvy investors buy and sell stocks — as investment research firm Morningstar explains it — is that they provide the highest potential returns. “Over the long term, no other type of investment tends to perform better.”

Analyses in several markets illustrate the benefits.

In the United States, for example, Morningstar said that stocks returned an average of 10 per cent annually over nearly the past century, while bonds averaged 5.1 per cent and short-term investments averaged 3.3 per cent, before inflation.

Here in Singapore, GYC Financial Advisory said that investing in the local stock market yielded a return of 9.0 times from 1975 until late-2017, and investing in the global stock market would have yielded a return of 12.5 times, after adjusting for inflation. That compares with a return of 6.5 times after inflation for property investments, based on Singapore inflation and data from the Department of Statistics.

Looking at the returns for a person who puts S$100 a month into a regular savings plan that invests in an STI exchange-traded fund (ETF), SGinvestors.io — an information-sharing platform for investors — said that monthly investments from January 2013 to December 2017 would have generated a return of 7.1 per cent annually, excluding transaction fees, which could be better than the average for bonds.

Nikko AM also said that although Singapore corporate bonds have provided better returns than government bonds and more stable returns than Singapore equities, the estimated return on a Nikko AM bond ETF from 2012 until mid-2018 was about 3.2 per cent. This yield is higher than the 2.1 per cent on Singapore government bonds, yet well below that 7.1 per cent for stocks.

While the returns on stocks are good, Morningstar also acknowledges that stocks tend to be the most volatile investments.

Investment advisory firm Motley Fool noted, though, that volatility is a cornerstone of the stock market and isn't really something to be afraid of.

Stock market fluctuations — even sizable ones — are completely normal.

HAVE A WELL-DEFINED INVESTMENT PLAN

Investors with a high tolerance for risk and a long-term investing horizon may well accept rises and falls in the price of stocks as a normal risk that justifies the higher returns.

For many investors, however, watching drops in their investment portfolio can be difficult and stressful. It is important then, to manage your investments well.

Instead of being worried about volatility, investment management firm Fidelity suggests that investors “be prepared”.

A well-defined investing plan tailored to your goals and financial situation can help you to be ready for the normal ups and downs of the market, and to take advantage of opportunities. Fidelity also noted that stock markets have had a positive annual return more than 80 per cent of the time over the past 35 years, even though they averaged drops of 14 per cent during the year.

One way to reduce the volatility can be to diversify your portfolio.

If you invest in stocks, selecting an index fund or ETF can reduce your risk by diversifying across a range of sectors.

If you invest in individual stocks, it is better to choose at least 15 to 20 stocks across a variety of sectors and categories.

You can also reduce the volatility by diversifying into both stocks, which can offer a higher return, and bonds, which can be more stable.

The ideal mix depends on factors such as your age, risk tolerance, and retirement plans.

As a broad guideline, putting about 60 per cent or less of your funds in stocks and the rest in bonds or real-estate investment trusts (Reits) can help smooth out the bumps.

It’s also important to match your investments to your timeframes.

When you are in your 20s or 30s, there is time to recover from short-term losses on stocks and achieve long-term gains.

If you were closer to retirement, however, it would be harder to overcome drops in stocks.

While there is no guarantee that you will make money on your investments, putting money into stocks has been shown to produce better returns over the longer term.

Investing at least part of your money into stocks can help you gain the freedom and lifestyle you want at an earlier age than investing in some other types of assets.