Last year the stock market went up some 30 percent, the best year for stocks in over a decade. People are making lots of money, so you might be tempted to get in on the action.
On CNBC and Bloomberg commentators constantly talk about the hottest stocks, usually focusing on the latest Internet trend. They gush over Google, fall over themselves for Facebook and go on and on about Apple, Twitter and Netflix. The newer the better. IBM, Hewlett Packard, GE and even Microsoft all now seem like your grandfather's stocks.
But be careful. The most expensive words in the English language can be: "Let's get in on the action."
The fact is, it's not the newest, most talked-about stocks that make you the most money. Over time, it's often the old-fashioned and well-established companies that prove to be the best investments. Here are four reasons boring stocks are better than the latest hot company:
1. Long-term gains are better. According to research by Nardin Baker at the management firm Guggenheim Partners, from 1990 through 2012 a portfolio consisting of the 10 percent of stocks with the lowest historical volatility did 19 percentage points better per year than the 10 percent of stocks with the greatest volatility. The most volatile stocks actually lost money at an average rate of over 11 percent a year. The least risky stocks beat the riskiest ones in the U.S. stock market, and in other global markets as well. And the gap persisted across most shorter time periods. Peter Hafez, director of research at the London firm RavenPack, attributes this gap to the news flow. He says low volatility issues typically rise more than high volatility stocks when the news is good and they fall less when the news is bad.
2. You are more likely to stay the course. Many investors buy when times are good and the market is up, and then get scared and sell when stocks are down. Or they might be too fearful to buy into the market in the first place. But widely held, lower volatility stocks usually represent larger companies with more stable earnings and more proven business models. These stocks may not gain as much during bull markets, but they also don't lose as much during bear markets. Investors can be more comfortable investing in these big, stable companies in the first place, and they're less likely to panic and sell out at just the wrong time.
3. You get more income. Companies on the cutting edge are forced to commit a lot of resources to research and development, just to keep up with their competition. They have to stay on top of trends and the latest technology. Boring companies in well-established businesses spend less on research, and can therefore return more cash to their stockholders. It's no secret that telephone stocks, as well as energy, utility, basic material and consumer staple stocks, generally return more cash to shareholders through dividend payments. As just one example, over 80 percent of large cap companies in the S&P 500 pay dividends to shareholders, while only about 40 percent of the smaller, more nimble companies in the Russell 2000 pay dividends.
4. You can sleep at night. It's exciting to own the latest stock that everyone is talking about. There's an adrenaline rush when it makes a big move. But that entertainment costs money, as investors bid up the stock price to capture the excitement rather than the true value of future returns. Buying a hot stock is a little like buying a lottery ticket: Sometimes you win big, but most of the time you lose. And when those losses mount, they can threaten your entire portfolio, along with your plans and dreams for retirement. An old Wall Street saying warns us: Don't take so much risk that you can't sleep at night.
There are dozens of stocks to pick from in the S&P 500 that offer better dividends than what a bank or a bond pays out. But for most people an ETF or mutual fund holding a basket of these stocks, such as the S&P Low Volatility ETF (SPLV) or Vanguard's Wellington mutual fund (VWELX), is the safer way to invest.
Tom Sightings is a former publishing executive who was eased into early retirement in his mid-50s. He lives in the New York area and blogs at Sightings at 60, where he covers health, finance, retirement and other concerns of baby boomers who realize that somehow they have grown up.
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