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What you need to know before dumping stocks

It's okay to give up on stocks.

"If you do not want to invest in equities, that does not make you dumb," says Carl Richards, author of The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money.

This needs to be said because we live in a world where stocks long ago won the image war in investing. Stocks are for hunters, while bonds and guaranteed investment certificates are for gatherers. Smart people buy stocks, sheep buy the other stuff.

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If all that's keeping you in stocks is peer pressure, for God's sake get out. Don't be naive about it, though. The move out of stocks requires both sacrifice and the ability to resist temptation.

"I know plenty of people who don't want to take equity risk any more – it's not a problem," said Mr. Richards, a Utah-based adviser who regularly contributes sketches explaining investing concepts to The New York Times' Bucks blog. "But let's build a plan where you save a little more and work more in retirement."

Mr. Richards' book doesn't tell you how to invest – it tells you how to think about investing so you make better decisions. The approach makes him the perfect person to consult on the case of the frazzled investor who wants out of stocks.

People who have lost money in stocks may question why he believes that safe investing requires you to save more and work longer. After all, bonds and stocks have pretty much generated nearly equal returns in the past 10 years in Canada at roughly 6.5 to 7 per cent annually. Can this be repeated in the next 10 years? Only if the global economy collapses and interest rates fall, thereby pushing bond prices higher.

The experience of owning stocks versus GICs and bonds in recent years has actually warped the minds of investors. Mr. Richards calls this recency bias. "It's the natural tendency to take recent experience and project that into the future," he said. "Mostly, we do it out of a need to make a complex world simple."

Here's the problem with using the past 10 years of investment returns as a guide to what's ahead. Stocks, over the long haul, offer both more risk and the potential for higher gains. Bonds are safer and thus pay less. The conclusion to be drawn here is that a 10-year period of parity in performance for stocks and bonds is an anomaly, not a rationale for over-emphasizing bonds in your portfolio. In fact, it's not unreasonable to expect a big stock market rally at some point in the years ahead that will be coupled with a bear market for bonds.

If you take the no-stocks approach, brace yourself for an onslaught of regretful feelings about your decision to abandon stocks. Mr. Richards warns that you could put yourself at risk of entering a brand new wealth-destroying cycle of investing in stocks, finding them too risky and then giving up on them. His bottom line: "If you're going to get out of the market, make it a permanent decision, please."

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Avoid stocks if you can't bear stock market risk. But don't base your decision on the idea that the stock market won't ever break out of its current cycle of making money for investors and then grabbing it right back. Mr. Richards suggests you look at the long-term numbers for the stock market. In Canada, the S&P/TSX composite index averaged 8.7 per cent annually for the 20 years to June 30, a period that includes the bull market 1990s and two market plunges since 2000. The S&P 500 made 8.3 per cent annually over that period, although this return slips to 7.4 per cent for Canadians as a result of our currency appreciating against the U.S. dollar.

You should also ignore any experts who use recent volatility to argue that stocks are dead as an investment for the average person. "Every other time someone has told us this, it's been wrong," he said. "The question is this: Is global capitalism going to continue to work? If it is, what's the most logical way to expose ourselves to that? The answer is in a broadly based, diversified way."

If you still feel abused by the stock market, it could be because you have more stock market exposure than you should. Mr. Richards describes an overweighting in stocks as speculating in the market without realizing it.

While he believes that decades of stock market history argue for having some stocks in your portfolio, he's realistic about the possibility of more upsets to come. "Of course it's possible," he said. "That's why they call it risk."


What do your fellow investors think about the stock market as a place to invest for the long term? Find out on my Facebook personal finance page. Click the "subscribe" button for regular updates.

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