Updated on Mar 02 2018
Stocks are a fundamental building block of a successful retirement portfolio. In retirement, the potential return from stocks over time is more likely to outpace inflation when compared to the long-term returns from cash or bonds. Investing in stocks can be risky, though. Investors are met with a range of possibilities, each with their own advantages and disadvantages.
What are stocks?
A stock is a share in the successes of a company. Basically, a stock holder owns shares issued by corporations that are a claim on the company’s assets and earning. As you acquire more stock, your stake in the company becomes greater.
Owning stock gives you the right to vote in shareholder meetings, receive dividends—which are the company’s profits—if and when they are distributed, and it gives you the right to sell your shares to somebody else.
If a company is doing well and the stock value increases, you always have the opportunity to grow your investment. The foundation of a stock’s value is directly related to company profits. So, as a shareholder, you are entitled to a portion of the company’s profits.
What are advantages of stocks?
Stocks are often considered a necessary ingredient in an investment portfolio as they can increase your return more than other investments. Here are a few advantages:
- Historically, stocks have proven to be beneficial for investors; even though the rates rise and fall on a daily basis.
- Most stocks are liquid, which means they can readily be sold or bought at a fair price.
- As an investor in a company, you reap the benefits if the company does well.
- The potential loss from stock bought with cash is quite limited to the overall amount of the initial investment.
- Stocks have the potential to deliver much better gains over time, compared to certificate of deposit, bonds or other investment alternatives.
While your return on your stock investment over time is quite good, it’s still important to diversity your portfolio and balance conservative and more ‘safe’ investments with the risk you take on when you invest in stocks.
What is a decent return for non-professional investors?
Over the past 100 years, the stock market has produced close to an average 10 percent rate of return. Adjusted for inflation, that means stocks could potentially double the value of your money in just over ten years at their average long-term return rate. This does not mean, however, that you are actually earning 10 percent per year on your money. In fact, real ‘rate of return’ is a topic that is frequently debated among financial professionals as there are so many variables. It’s no secret that investing can be tricky, which is why it’s smart to do your research or enlist a professional financial advisor to help you navigate the market. Conservatively, you might assume an expected rate of return closer to the 7 to 8 percent range.
What are the indicators of a stock’s health?
Publicly traded companies issue quarterly earnings reports to the Securities and Exchange Commission (SEC). According to Forbes’ financial services expert Stephanie Taylor Christensen, the material from these reports can help you evaluate a stock’s health:
- Earnings per share (EPS) – The ratio of total earnings divided by total investor shares. This number can help you compare stocks.
- Price / Earnings ratio (P/E) – This is what customers are paying for a dollar of the company’s earnings. Generally, the long-term average number has been about 15, according to FINRA, so a stock with a high P/E might mean the stock has a positive future, whereas a low P/E might mean that either a price increase is on the horizon—or that a company is in trouble.
- Price / Book ration (P/B) – When comparing stocks in the same category of market, this ratio can indicate what shareholders are willing to pay compared to the company’s reported value.
- A value less than 1.0 could indicate the price is trading lower than the actual value of a company, signaling either an opportunity to buy low or that the company is struggling.
Some figures can be more telling than others when determining a stock’s health and the best performing stocks, which is why an expert financial advisor’s help can be beneficial. Depending on your unique profile, you may want a specific type of investments for your portfolio, and many variables contribute to which stock make the most sense for your unique investment performance and growth strategy.
What are disadvantages of stocks?
Stocks represent participation in a company’s growth. There are no promises about returns of your initial investment. In fact, the profitability of the investment depends on rising stock price, which is directly related to the performance and growth, or increasing profits, of the company. Buying stocks can be a bit of a gamble as you can’t always predict the successes of a company.
Here are the main disadvantages:
Stock values can change for no apparent reason, which can be quite frustrating for the investor who’s trying to anticipate the behavior of the stock based on the actual performance of the company.
Prices of stocks can be volatile. Prices can rise, be irregular and decline fast. Such declines sometimes cause investors to sell and panic, which results in loss.
Investors in a certain company might not know all that there is to know about the company. Due to this insufficient information, making an investment decision can be difficult.
While shareholders invest in a company, they don’t have the privileges and rights that the owners of privately held companies have.
Stockholders are the last ones to get paid since the company pays their employees, creditors and suppliers first.
Stockholders have tax implications.
What percentage of my investment portfolio should go toward stocks when retiring?
Experts recommend allocating 40 percent or more of your portfolio to stocks during retirement to help sustain one’s standard of living for a 30- to 40-year period. Here are a few things to think about when investing in stocks:
1. Risk Appetite
Older investors have a shorter time horizon to recover from market volatility, so stock investments should be more conservative, to a degree. Target date funds are designed around expected retirement age. While they can be good for investors in the long run, there are some risks:
Most target-date funds are funds from one company, which may not have the top managers in each of the asset classes.
Investors give up control on where to overweight and underweight their investments.
If you have spare funds, you can afford more risky investments. A financial advisor can help determine your ideal level of investment risk as well as assist with the transition from high- to low-risk investments.
2. Asset Allocation
Asset allocation refers to the selection of securities and asset classes in which one can invest. It’s the same idea that you might hear referred to as “portfolio composition” or, more simply, “investing mix.” Asset allocation varies widely on a number of factors:
- Age –
- Age determines which investments make sense as there are a number of time variables
- Financial resources –
- “Accredited” investors, those who have at least $1 million to invest, can put their money in alternative assets, not just stocks, bonds and mutual funds.
- Risk willingness / Investment risk –
- Those eligible for “Private” funds include hedge funds, private equity funds, venture capital funds and more. The structure of these funds and types of investments can be a lot more dangerous and difficult to understand.
3. Portfolio Diversification
No matter one’s age, a diversified portfolio that includes large-cap U.S. equity, fixed income and international equity is ideal.
Gradually increasing your stock exposure is recommended to get the most return from stock investing. Consider enlisting a retirement financial advisor for expert direction on the market and your unique situation. Financial planners or fiduciaries can help you invest comfortably for retirement, no matter your age or budget.
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