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Are Stocks Too Risky?

This article was written by in Featured, Investing. 29 comments.


When it comes to investing for the future, there appears to be an interesting dichotomy. The typical financial advice marketed to the middle class — upper and lower — calls for long-term growth through investing in the stock market. The typical sales pitch — and I use “sales pitch” as a general term, not necessarily something you hear from a salesperson, but often you do — mentions or implies an almost guaranteed return of 8%, sometimes 10% or 12%, over any thirty-year period. For many people, the stock market is their only hope for collecting enough wealth for retirement.

For the most part, wealthy people have a different approach to building for the future. Owning companies and investing directly in businesses, when successful, are much more successful than investing in the stock market. Don’t forget that a lot of investors of this type fail or go bankrupt. Occasionally they continue trying until they become one of the success stories, but often, survivorship bias dooms them to oblivion forevermore. For those who succeed, once that wealth has been built, goals turn towards eventual retirement and the cessation of the hard work of diligent company-acquiring or fervent CEO-ship. It’s not the stock market for these folks, however.

One of my favorite examples is Suze Orman. She is one of the most popular television personalities, and she doles out financial advice on television, on radio, and in her books. She, like most other financial advisers and planners, looks towards the stock market for long-term growth — for those who have the stomach to sit through short-term volatility. Peek inside her own portfolio, and you might find a different story. Suze prefers investing the bulk of her wealth in super-safe municipal bonds, triple-A rated, rather than stocks. The information on Suze’s portfolio is now a few years old, and it’s quite possible she may have shifted her asset allocations and changed her diversification, but the information is relevant. In 2007, just 4% of Suze’s non-real estate portfolio was invested in stocks — at a time she was recommending an allocation of mostly stocks to callers her same age.

Of course, age isn’t the only consideration. 4% of Suze’s portfolio in 2007 amounted to $1 million, and that amounts to larger exposure to the stock market than most middle class workers. Though I’m sure she wouldn’t like to lose $1 million, she could certainly afford to. She can take this small amount of risk. She doesn’t need to build up towards retirement; Suze could retire today and live off bond income for the rest of her life.

In light of the volatility in the stock market following the earthquakes and tsunami in Japan, analysts are saying the stock market is now too risky for investors. The risk doesn’t change depending on market condition, however. The risk has always been there. There is some kind of association in the bran that makes people think that when stocks are going up, stocks are the best methods of building wealth, while when stock markets are volatile, they are bad. The equity market doesn’t change characterization overnight. The same rules apply — there is always risk in the stock market. Those who can afford to take the risk do so appropriately. Others who believe the stock market is their only hope for a comfortable retirement invest because, thanks to the financial planning industry, they believe they must. Those who don’t want to take this type of risk run companies and acquire businesses. There is risk in that, as well, and in fact those who do are often more exposed, but most have determined that bouncing back is possible and are willing to put the work in the promise for greater returns than the stock market and, perhaps more importantly, never being required to put the bulk of their money at risk again.

Do you believe that owning companies and investing in businesses is a better way to prepare for retirement than investing in the stock market, even index mutual funds? Is the stock market just too risky today?

Photo: Cyron

Updated March 24, 2011 and originally published March 22, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 29 comments… read them below or add one }

avatar Jon | Free Money Wisdom

I’m going to have to say that stocks are not “too” risky. It all depends on how you invest your money. If you are stock picking, then yes, stocks are too risky. THat would be risky due to putting all your money in just a couple companies. However, if you are indexing or putting your money in ETF’s/mutual funds, then stocks are less risky. Stocks will always be the best way to increase the oh so sweet return. But the key to to keep your investments diversified.

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avatar Robert @ The College Investor

Jon has a point that picking stocks can be risky. Just like owning one stock can be risky (say your company stock in your 401k).

I think over the long term (20+ years), historical evidence has shown that investing in the market as a whole (so an index fund), out-performs other investments. Since there are bubbles and busts, as you approach an age where you need the money, you should be shifting out of the stock market and into assets that are safe.

Suze Orman, for example, doesn’t need to work, and when she does, I would say her income isn’t steady (i.e. TV shows and book releases). As a result, it makes sense that she is not invested in the stock market because she may well need the income generated from her portfolio to live.

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avatar Jon | Free Money Wisdom

Be careful, past performance is no measure of the future. However, stocks have always done better for the long term.

Suze Orman not investing a majority of her money in stocks makes a lot of sense actually. With that kind of wealth, you don’t really have the necessity of taking on extra risk to make a couple more percentage points. It’s a much wiser/safer bet to get modest gains with that much capital and coast on that money. It all comes down to your total assets and your time frame.

Also, when it comes to bubbles and bursts, those don;t matter for a long term investor. If anything they’re great, because an investor can buy on the dips (I do this all the time). But in reality, the bulk of my money is invested through dollar cost averaging over the long term!

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avatar rewards ♦31 (Newbie)

Perhaps her low stock exposure is to minimize taxation.

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avatar Investor Junkie

How is owning “one stock” different than owning a business? Yes in a business you have much more control, but only so much.

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avatar Steve

People love to feel that they are in control. Classic example: people are afraid of flying but not of driving. The former is safer but the latter seems safer because of the illusion of control.

Owning your own business is a lot of eggs in one basket. It’s hard to decide if that is even a +EV basket, never mind the volatility.

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avatar The Dividend Pig

I don’t see any reason not to do both. The stock market produces good returns when invested in wisely and with patience, that is proven. There is risk in all investments: businesses fail, stock markets crash, real estate bubbles burst. Invest carefully, across markets, businesses, property, and yourself. It’ll be worth it in the long run.

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avatar Jon | Free Money Wisdom

You should ONLY do both if you maximize your 401k and roth-ira, then yes, I would advise anyone to pick up some quality dividend stocks at that point.

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avatar tbork84 ♦1,867 (Half-Dollar)

I definitely agree with you on that one. Many people are worried about what and how to invest when they aren’t taking full advantage of the best options already open to them.

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avatar Ceecee ♦53 (Newbie)

This is a great question! I am still trying to figure this out. I believe that the market has changed due to online trading. I only invest what I can afford to lose—-or won’t need for a really long time.

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avatar Investor Junkie

Flexo, the ironic part is she can afford to be much more risker with her investments and would not affect her wealth at all. IMHO if I was her I would be investing in much more than 4% of my total net worth, though maybe not as much as a typical person her age. Maybe 15% of my total AA.

Keep in mind also she’s invested in munis which are tax free. So it’s possible that she’s generating $750k tax free, which is a big difference than $750k at a 15% taxable even.

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avatar Jon the Saver

Well, it has two sides. One, she wants to reduce her tax burden. Two, she wants to protect her assets. When you are that wealthy, you really don’t care about making more, there really isn’t any point. Why do you think retirees move their allocation to 20/80 equities to bonds? They don’t want to take unnecessary risk while ensuring their gains over the years are protected. Makes perfect sense.

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avatar Investor Junkie

That’s the thing. Bonds are risky also. No such thing as a “risk free” investment. Bonds and specifically muni bonds are risky in other ways. Default risk, interest rate risk, and inflation risk are the three major ones. What matters with any investment is knowing the risks and taking actions to minimize those risks. This includes owning a business.

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avatar Jon the Saver

You’re spot on there Investor Junkie. Every investment has risk involved, but it comes down to risk allocation. Although bonds hold some risk, I would not say that they are “risky.”

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avatar SteveDH

Once again I find myself wanting to comment but being too old to talk about “preparing”. I’m retired and I can say that investing in stocks was a key factor in my retiring at 60. I used the Time-Marches-On approach in that I my exposure to stocks kept decreasing as I got older. Now retired and 63 my portfolio has about 30% equities with the remainder in bonds and cash. Somewhere between 65 and 70 that will drop to 20%. Additionally, at my age most of my equities are in the Income versus Growth sectors of the market. Taking big risk cannot be a substitute for not having a methodic savings plan throughout the work period of your life, but your number of years and degree of risk aversion should both grow along parallel paths.

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avatar Jon the Saver

Amen to that SteveDH! That’s exactly how I’m investing and I have my sights set on retiring at 55!

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avatar DonnaFreedman ♦75 (Newbie)

I come from a family that never had any money and never learned to think about investing. It was enough if a person paid all his bills on time and had a little bit left over to put in the bank.
Thus I had (still have, actually) an ingrained fear of risk and the idea that investing was for “rich” people, not for people like us. FInancial planners have a hard time with me. :-( Even as a much younger woman I’m afraid I was the “safest, slowest, least risky” (read: least profitable) kind of investor.
On the bright side, my 401(k) didn’t get as hammered as everyone else’s did in the recent unpleasantness.

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avatar wylerassociate ♦162 (Cent)

good column flexo.

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avatar jim

I don’t think that direct investing in an individual business is inherently better than buying individual stocks. Direct ownership or investment versus stock ownership are just different ways to own a business.

Theres pros and cons to either, but I don’t think that one is automatically more or less risky. It depends on the individual business or stock in question. My wifes grandfathers business has a 50 year proven track record and investing there is safer than buying Blockbuster stock. My friends wife talks about starting a store but she has no proven record running a store so she’d be a much more risky investment than buying GE stock.

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avatar Kathryn C

The average investor has no clue about how to pick stocks or invest in or “own” companies (which are one in the same, I agree with Investor Junkie). Investing in funds (or ETF or Index funds) to get stock exposure is best for the average investor.

But, the bond market (treasuries) is more risky than the stock market right now given where interest rates are.

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avatar Luke Landes ♦127,480 (Platinum)

I have to disagree that owning a few shares of stock in a sea of thousands or millions of shareholders is the same as owning a company. I own a few shares of Microsoft, so yes, I am one of the many owners Microsoft’s Board of Directors must answer to. Do you think I really have any say in the operation of the company? I have not put much of my “wealth,” such as it is, in that company. If I were the sole owner, or one of a few partners, who owned a company like that, you could bet I would be more involved with the operation of the company and my opinions would be given a considerable amount of weight. Someone who owns a company puts their reputation and their money on the line when it comes to the company’s success. Being a tiny shareholder in a public company carries nowhere near the same amount of risk. On the other hand, as a de facto owner of a company, you could be the reason it goes from a $1,000 a year business to a $1 million a year business.

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avatar Investor Junkie

IMHO there are similarities, but they are not exact. Obviously the risk is much different for each. Though owning a business and investing is about risk management.

Being a business owner helps you read financials and understand how businesses operate. If you don’t understand either you should definitely not invest in individual stocks. That’s not to say someone who doesn’t own a business can’t do these things. It’s just when owning a business you more or less a crash course in finance.

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avatar Kathryn C

Ok it’s official, I have a reading comprehension problem. I just re-read your post and I took the part of this sentence “Owning companies and investing directly in businesses” to mean “investing in stocks.”
I agree then with you. I have tons of friends who have their own businesses, but have no clue about picking stocks, so they don’t, and that’s a good thing. Honestly, I don’t even know if some of them know how to read financials very well. But they seem to be doing fine, for now.

I actually don’t see any comparison really between owning a business and investing in stocks now that I think about it….except for the part about maybe reading financials.

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avatar skylog ♦368 (Nickel)

i think the one point you brought up is so very important, the failure rate of businesses. while the rate of return may not be what one was hoping for with regards to investments in the stock market, with a balanced portfolio, the chances of one losing everything over the long haul is very low.

i just think the opportunity to lose everything owning businesses is something that can not be ignored. if anything, perhaps, the question should be “is owning a business too risky?”

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avatar rj

I think that investing in stocks is what most people believe that they should do, but they don’t really have a good understanding of the market. There is alot of opportunity for manipulation by automated trading programs.
here’s a link to a story about high frequency traders:
http://www.cbsnews.com/stories/2010/10/07/60minutes/main6936075.shtml

I’m just not interested in competing with computer algorithms. I like real estate much better.

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avatar Jon | Free Money Wisdom

Investing in stocks is what you should ALWAYS do. The percentage of equities changes as you get older. It’s not rocket science. Those articles about high frequency trading is just propaganda. if you invest for the long term, you will do great no matter what “market” manipulation” there is.

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avatar Richard Stooker

Not all wealthy people have their own businesses. And that’s just not possible for everybody. But thanks to the stock market, everybody can be a business owner and reap the benefits, without doing anything except buy stock.

The stock market is always risky if you’re hoping for a price increases. Buy stocks that pay dividends and hang on to them for the rest of your life, and you don’t have to care about where the price goes. Just collect and reinvest an ever-growing stream of dividends.

And even business owners should have as big an investment portfolio as possible. What if it all blew up tomorrow? Or you suffered a brain injury?

Suze Orman can afford to give up the benefits of stocks in return for the safety of municipal bonds because her income from her books and advice giving is so high. Most of us aren’t in that enviable position.

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avatar Abby Freedman ♦137 (Cent)

I think it’s always about diversifying. Much as I distrust the stock market — I’m always wary of anything that rides on people’s fears and optimism — it will need to be part of my investment plan. Then again, annuities are a good way to guarantee income, assuming you pick stable companies. The same can be said of bonds.

As for investing in businesses and owning companies, I’d say the odds are at least as bad as stocks. Granted, you may be investing in yourself or in ventures where you know the people have proven track records. But business is still risky and so investing in it can’t be that much safer than stocks, in the long run.

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avatar shane

Its only risky when you start trying to do value investing and finding good deals on the stock market. That actually is very risky. The problem is your buying a stock that is under its book value or overall value. What happens is people don’t know much about that business and the reason that business is low is usually not a mistake. there hurting financially or have a big law suit or a new better competitor competing against them. So to keep it safe you want to stay from fast competitive businesses like technology. Technology has bankrupted lots of my friends. I am one of the only ones that beat crash of 2009. People quickly sold i kept buying. But I don’t take risks, I bought stocks with big moats around them. Budweiser is number 1 beer seller, ups people need to mail stuff, walmart is the king of shopping centers, disney is the best family movies, pepsi, coke are 2 of the most addicting drinks, home depot is the best place for construction, peopel bought these mortgage companies you don’t need to if there building more homes get home depot they have to shop there, apple computer they have the i phone its pretty simple people want apple products, comcast cable people need cable and dont’ want a big satellite dish on side of there house, any oil company is good people need gas and you can’t go wrong with mcdonalds people will always eat there. All the companies i pick there is no risk. Yah they can go down but not out of business and not down to under 10 dollars. Banks are terrible buys. They get sued al the times, people don’t trust them and they have to much negative impact from society but all the places i pick are things every day people need regardless what happens. If these places go out of business the world is going out of business. I don’t touch anything people don’t need daily or dont’ have to have. Gold and silver and all those metals are huge risks. People don’t need those things every single day. Silver id choose over gold. Gold is the biggest risk. In the 80s in plummeted. People dont’ even know why there buying it they think its the worlds money. its the biggest scam i ever seen. Any time you buy something people dont’ really need its a scam. All the best investors don’t buy gold. People say it keeps going up but its gone down too. Dont fall for gold. I told people since last year if antyhing sell it. They keep buying it and its been going down all year. Stay away from gold and keep it simple. Nobody is beating america.

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