Five Reasons Why Stocks Can be BAD for Your Portfolio

Let’s start off by saying that we don’t actually believe that no one should invest in stocks. Done correctly, stock investing can be a great way to build wealth. However – most people aren’t aware of some key facts and potential pitfalls. Here they are…

1) The stock market hasn’t delivered great returns over the last ten years. In fact, the S&P 500 has delivered less than 3% on an annualized basis (for the ten year period ending December 31st, 2011). That includes dividends, but of course doesn’t account for inflation. Throw in the relatively low inflation rate we had during that same period and the real returns are more like 4%. Not 4% per year, but 4% total for a decade! It’s hard to see how the average investor will be able to retire some day if that’s the best overall return rate they can get.

2) There has been a bright spot in international stocks, especially for companies headquartered in developing countries. However, in many developing countries the “rule of law” is still, well, developing – and you really have to watch out for corruption. Without being in the country and intimately knowing the company whose stock you’re buying, it can be difficult to sort out the honest businesses from the corrupt ones. And the corrupt ones won’t be concerned with the quality of their financial reporting, which can leave you holding the bag on a worthless stock.

3) Keeping a basket of stocks (or even stock mutual funds) doesn’t necessarily mean that you’re diversified. It used to be true that large cap / small cap allocations or domestic / international allocations could help provide a reasonable degree of diversification, but that’s not so true anymore. To truly diversify your portfolio, consider complementing your stock investments with other alternatives such as oil & gas MLPs, managed futures, and/or real estate.

4) The stock market is volatile. It goes up and it goes down – sometimes a lot. When it goes up people tend to buy and when it goes down people tend to sell. It’s human nature, but that kind of behavior can lead to very poor (maybe even negative) long term portfolio performance.

5) The market’s volatility can have another serious consequence, and that is if a major downturn hits at the wrong time (as it did for so many in late 2008 and early 2009) your heavily-weighted-towards-stock portfolio can get pummeled. When you are young, you still have time to recover. But if you’re at or near retirement age that kind of event can be life-altering. You can mitigate that risk by not keeping all of your investment eggs in the stock market basket.

So, there you have them – five reasons why stocks can be BAD for your portfolio.

Source: Moneychimp.com website: CAGR of S&P 500 Stock Index from Jan 1st, 2002 to Dec 31, 2011

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