Economics of Stocks: Account Considerations
Investors buy stocks so their investments grow in step with the companies that issued the stock. Some investors enjoy betting on individual companies, but most prefer to invest in pools of stocks that either are chosen by a professional manager or track a particular index.
Inflation and Return Expectations
Economic growth has historically helped stocks outpace the performance of bonds over the long term. Investors favor stocks as the growth engine of their portfolio, but returns don't come without risk. Large cap U.S. stocks that have returned, on average, about 10 percent per year over the last century have spent many individual years during that time in the red. It's great to think that U.S. stocks will earn 10 percent every year, but that's an average over a considerable time. You might need your money tomorrow, when a given stock is struggling, and can't wait around for the 10 percent average to develop. Chapter 10 will help you set a mix of investments to help deal with risk.
Active Versus Passive Investing
There are two general schools of thought among investors. One school, the active investor school, believes that, with skill and diligence, an individual investor can find investments that can outperform the overall market. The other, passive school, factors in the time, cost, and complexity of the active approach and concludes that the market is efficient over time and no one individual can beat market performance consistently.
An efficient market is one like the U.S. large-cap stock market, in which all investors have the same information at the same time. It's difficult for any individual to trade on information that no one else has. Inefficient markets are ones where information is scarcer. Small-cap markets in the United States and some international markets are inefficient enough that skilled investors can make a difference.
Many studies have been done proving the relative merits of active and passive investing. Most busy investors prefer to make investing as easy and hassle-free as possible. These investors choose a passive approach in most markets — large and mid cap U.S. and developed international — and an active approach in less efficient markets — small cap U.S. and emerging international. They also choose an active approach when a particular manager offers to buy stocks that fit a particular personal value the investor desires, such as in so-called green or socially conscious investing.
Green and Social Investing
More and more people are interested in investing to match their social and environmental priorities, and investment managers and corporate boards have raced to accommodate them. Companies tout their efforts to protect the environment and boast about their socially friendly policies and values. Investment managers buy the stock of these companies not only to profit from sound technologies or beneficial work force policies, but also to encourage the company's behavior.
Adding green and/or socially conscious investments to your portfolio is a great way to match your investing with your values. The world economy still isn't green or socially conscious enough so that your whole portfolio can be invested this way, but a lot of it can. Buy investments in the countries and industry sectors that fit the green/social model you're looking for, and then fill in the rest of your portfolio with passive investments that follow the market indexes.