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Is investing in stocks worth the risk?
Compared to cash, bonds and even the canned goods in your pantry, stocks come out on top -- until you consider the risk.
By Scott Burns
Here's a deeply rude question. Should we stop investing?
I'm serious. Under current conditions, saving and investing is worse than frustrating. It isn't worthwhile. There must be better uses for our money than investing in stocks, bonds or money market funds.
Yes, I know: This is close to blasphemy in the financial world. But that's how it looks. There are thousands of investments out there. Most of them aren't providing a decent return. Maybe that's why Bill Gates is planning on giving his $3.2 billion dividend to charity.
Let's start by comparing four places to put our money: stocks, bonds, cash and objects. We're going to consider total returns and the impact of taxes and inflation. When we do this, cash comes out worst. Stocks are a sorry best -- but we'll work our way up from the bottom.
Cash is king? I dont think so
Cash. This is the money we keep in money market mutual funds, Treasury bills and other highly liquid forms of investment. Right now, money market mutual funds yield about 1%. Many are earning less. The difference between 1% and one-half of 1% doesn't mean much. Once your yield is pathetic, it's pathetic all the way down.
Taxing this yield could be the new definition of "adding insult to injury." Assuming a 25% tax bracket, a 1% yield is down to 0.75%.
The official inflation rate for the 12 months ending June 30 was 3.3%. But the trailing three-month rate was 4.8%. So we'll pick a number in between, say, 3.9%, as our inflation estimate for 2004. That means we're losing purchasing power at the rate of 3.15% a year. Cash is trash, except that you can lose a lot more elsewhere.
Bonds are a slightly better bet
We can do better than cash. All we have to do is buy bonds and take the risk that interest rates will rise. If they do, our return on bonds may well net to the return on cash, as it did for most investors over the last 12 months. (In the 12 months ending July 23, according to Morningstar, the average total return on PIMCO Total Return, Vanguard GNMA and Vanguard Total Bond Market funds -- the three largest fixed income taxable bond funds -- was 2.98%. All three did better than their category averages.)
But let's not worry. It's pretty easy to get a 4% yield on an intermediate-term Treasury these days; we'll go with that. After we pay income taxes, our 4% is down to 3%.
That means our after-tax, after-inflation return is a loss of 0.9% -- provided interest rates don't rise.
Investing in 'stuff'
The sales force of the investment/retirement complex won't tell you about this because it won't put food on their tables, but buying canned food for our tables (and other stuff) is a pretty good use for money. If what we buy rises in price with the general rate of inflation and we still have it at the end of the year, you've broken even. We have no tax liability. Our "return" is 0.0%.
True, the return won't put us on the cover of Money magazine. But it beats bonds and cash. The hard part is finding the "stuff" that rises as much as, or more than, the general rate of inflation.
Time to find stock alternatives
According to Ibbotson Associates, large-capitalization stocks enjoyed annual capital appreciation of 5.9% a year from 1926 through 2003. Add the current dividend yield of the average stock, 1.5%, and we can look forward to a total return of 7.4%.
Rather nice. Also, it's taxable at a bargain 15% rate. It nets us 6.3% before inflation and 2.4% after inflation. That's better than losing money or breaking even -- until we consider the risk. Stocks don't rise 5.9% a year like clockwork.
Conclusion?
It's time for us to reset our investing habits. Except for savings dollars going into 401(k) plans where the employer matches our contributions, we need to look for other uses of the money we save.
See Scott Burns' Web site.
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