Equities are the best investment (most of the time)
When working people start accumulating money, they need to invest it somewhere. European and North American banks no longer pay reasonable interest rates for current accounts and even deposit accounts. The Chinese stock market bubble burst has dominated the business news this summer (summer of 2015). It went down some 40 percent in less than 3 months. With the frequency of such bubble bursts, the average person can be forgiven for thinking that investing in equities is too risky. And so a lot of people end up investing in real estate. The conventional thinking goes that although real estate bubbles exist - as evidenced by the latest crash in 2007- real estate values will never go down to zero. Or if they can’t afford it then they invest into interest bank accounts (where they still exist)
The Lehman Brothers crash has been on the minds of a lot of investors in recent years. There were indeed several fortunes that got wiped out when that bank went bankrupt. Some people thought that this company was too big to fail and invested most of their savings it in. And that was their first mistake. I will grant you right now that if you want to invest in the stock market but don’t understand anything about finance and don’t want to pay for the advice of a financial manager, then yes, you should invest in something else. Although, total ignorance also lands you in trouble when you invest in real estate. Your safest bet at that point is your local bank.
Financial advice is available for the wealthy investors and the average person who wants to save for his retirement. And the first advice and rule of investing is “Don’t put all your eggs in one basket”. This has been the great insight in finance in the past 40 years. If you plan to invest in an equity with a certain return, you can do better by placing your money in a diversified portfolio with less risk. An investment adviser would have told those unfortunate investors to not put all their savings in Lehman Brother’s stock but rather in a diversified portfolio of banking and other stocks. In which case, as the stock market recovered from they would have seen their investments increase since 2007.
And for years now there have been many options for equities investors to diversify their holdings. One popular investment vehicle is an Exchange Traded Fund (ETF). Such funds track financial indices which means that they hold a diversified portfolio of equities as to behave the same way as the market index they track. At this point they are said to be shielded from the unsystematic risk which is the risk associated with the idiosyncrasies of individual companies and are only exposed to the systematic risk of the market as a whole. Not to say what are known as black swan events, the extremely rare events of whole market failures, can’t happen. ( the expression was coined after the discovery of black swans in Australia, before that time swans were thought to be white). But the history of the American financial market over the past 115 years shows that the only period where it took a long time for it to recover was the Great Depression of 1929 (the market recovered in the 1950s). The mathematics of diversifications are covered by the CAPM theory.
Why take any risk? The bottom line is that equities yield a higher return on investment than any other type of investment. Most economist agree with this insight. Robert Schiller the Nobel prize winning economist documents this quite well in his books. Indeed, a long term investment in an ETF that tracks the S&P composite index will yield 10 percent over the long run. This is better than most investments in real estate or anything else. But on a more fundamental level, this idea should make instant economic sense even for someone with a minimum of financial knowledge.
Real estate investment rests on the assumption that land is scarce and there will always be more people. While the first of these assumptions is true, the second one is open to debate, especially with the falling population rates in western countries and China. And even if populations were rising, governments and developers have found a solution for housing shortages by creating new cities. Indeed, a lot of China’s new cities lie empty these days, evidence of how the burst of the housing bubble. Once we account for that, then having many houses should not yield a high return. On the other hand, as long as people work, corporations will make profits. And these profits will be distributed to investors or reflected in stock prices. An investment in a corporation is an investment in work or productive labor. And it is labor that grows economies. So it is natural for it to be the highest earning investment.
With that in mind, the lay investor should use the currently available professional investment advice to put money in equities. This said however, the more diversified a portfolio the safer it is, so a combination of equities, real estate, bonds and other investments will yield the maximum return. And as it happens there are investment mutual funds, and other investment programs that make this possible. Equities are the best investment, but because they are so most of the time, your average investor needs to be hedged against those times when swans turn out to be black.
Sources:
Mutual Fund: http://www.investopedia.com/terms/m/mutualfund.asp
Robert Schiller: https://en.wikipedia.org/wiki/Robert_J._Shiller
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