Why should you invest in stocks

Equities, or stocks, is what you most often hear about. But what are “stocks?” As you know, almost every economic activity on this planet is structured as “a business.” A company. A corporation. Most of these corporations are private companies. Your local baker, and your local dentist, are such private businesses, owned… well by your local baker and your dentist. Sometimes a private business can be very large however. Cargill, a company 155 years old, with USD 188 billion in revenue per year and 166.000 employees, is a private business, owned at 88% by the Cargill family. Fidelity Investments is also a private business. So is Mars, the food business. You cannot buy into these businesses unless you speak to their current owners, i.e. your local dentist or the Cargill family, and they agree to sell you part of their company.

Other businesses however, are public. What this means is that their shares trade openly, and freely, on a stock exchange such as the NYSE (New York Stock Exchange), the LSE (London Stock Exchange), the TSE (Tokyo Stock Exchange)… This is why public and “listed” companies are the same thing — to be public, at one point, a company needs to list itself on a stock exchange through an Initial Public Offering (an “IPO”), and it has to stay listed there. Many countries have their own stock exchange. For practical purposes you can focus on your own country’s stock exchange, and the largest ones in the world namely US ones, the European ones, the Greater China ones (Hong Kong, Shanghai, Shenzhen), Japan, South Korea, and Australia. In brief, the “public” like you and me, can buy and sell the shares of public companies on these exchanges without asking for anyone’s permission — the market makes the price, and everyone can buy and sell on the market.

How do you access an exchange? Well as a private individual you need to go through an institution, like a brokerage or a bank. Charles Schwab, TD Ameritrade, Interactive Brokers, IG, and most banks on this planet can give you access to buying or selling shares of public companies. If you live in any large country/economy it is the case that many of the most famous companies in your country are public companies. What this means is that you and me can buy shares — we become co-owners — of some of the largest companies in our countries. Instead of just being a customer and withdrawing money from HSBC, filling your gas tank at a BP gas station, using Microsoft Word, or googling “how to get rich,” why not also become a co owner of these companies? Next time you shop at Walmart, or eat at KFC, or go to Disneyland, and spend your hard earned money there and think they are making a lot of money off you, you could be one of the co owners of those businesses. Some of the profits could come back to you! And if you think they are great businesses, and they are great at extracting value from you (ripping you off and keeping you coming for more), you could make some nice money! At least you would benefit as well from the spending that you and millions of people like you do there. This is one of the most powerful realizations you can make as an individual investor: while most companies are private, there are many companies, whose products you use every day, that are public. And you can be a co owner of these businesses.

Why own stocks?

Aha! Good question. You own stocks because they are the greatest source of wealth creation of the past century or more. Let’s look at the American, German, Spanish, French and Hong Kong stock exchanges:

American stock exchange S&P 500, 1927–2020:

While the S&P 500 has experienced a tremendous growth in the 20th century, we also see some dips, such as the early 2000s, or around 2008–2009. The stock market is not a constant, stable, investment that never goes down in value. Sometimes it does. But over long periods of time, it tends to make a lot of profits for a lot of people.

German stock exchange DAX, 1987–2020:

Spanish stock exchange IBEX, 1993–2020:

French stock exchange CAC 40, 1990–2020:

Hong Kong stock exchange Hang Seng, 1986–2020:

Between 1926 and 2020 the shareholders of S&P 500 realized USD 47.4 trillion dollars in total profits. Between January 1927 and August 2020, the S&P 500 grew a total of 25599%, an annualized return of 6.1%. Had you reinvested your dividends during this period, the S&P 500 gained 841603% over this period, or 10.1% per year. Adjusting for inflation, the S&P 500 still grew 56607%, or 7% per year if you reinvested your dividends over this period.

Let’s bring things closer to us:

If you invested USD 1 in the S&P 500 (American stock market) in 1974, you would have 154 today: this is 154 times your initial capital. If you invested USD 1000, you would have 154.000 today. And let’s take the most recent 20 years, the period 2000–2020. This period experienced the dotcom crash, the 9/11 terrorist attacks, two foreign wars for the US, the most important financial crisis since the Great Depression almost 100 years ago, the downgrade of American debt… It was far from a quiet period for a stock market investor. However, if you invested in the stock market in 2000, you would have benefitted from an annualized return of 8.2%, or 5.9% adjusted for inflation. You could have grown USD 10.000 into USD 31.200 over the past twenty years, or 3 times your initial capital.

And this is why stocks are a core investing tool for all of us, and why it is a shame that so many people do not take advantage of this.

Dividends

Aristocrats

People hold stocks as an asset because as we’ve just seen, over long periods of time, the stock market can generate a lot of profits for stock investors. But there is one more important reason to invest in stocks: this is dividends. Some companies’ CEOs and management teams want to remunerate their owners (their bosses i.e. you), more than just by working hard so that the company’s stock price goes up. They do this by paying the company’s owners (you) dividends. These are regular payments, typically quarterly, that the company makes to all its shareholders.

Let’s take the example of GlaxoSmithKline, the very large British pharmaceutical company, one of the largest in the world. At the time of writing, it pays a quarterly dividend of 19 pence in British pounds. This means if you own 100 shares of Glaxo, every quarter, the company pays you 19 pounds (19 pence per share * 100 shares = 19 pounds). This is about GBP 72 per year (19 per quarter times 4 quarters), which you earn just for holding shares of this company.

Companies that pay regular dividends tend to continue paying regular dividends, and the amounts tend to change slowly over time as opposed to drastically from one quarter to the next. But dividends, like the world, change over time of course. In December 2009, Glaxo was paying 61p in quarterly dividends. This means if you owned 100 shares the company’s management was paying you 61 pounds per quarter or 244 pounds per year for being a co owner of the business. Let’s look at some dividend examples among US companies:

As you can guess, some investors make very nice quarterly cash simply by holding such dividend paying companies. I know many investors who after a while manage to live simply off their dividends payments — any appreciation in the company’s stock is simply “bonus” from then onwards!

How to buy stocks?

Everyone in almost every country can buy stocks. At the very least you should be able to easily buy stocks in the companies listed in your country, and US companies, with other major markets such as European stocks also usually offered.

You can buy stocks in the industry you work in/know well (as Peter Lynch, who managed Yale’s Endowment and has one of the most impressive investment records ever accomplished advises us all to do), you can buy stocks you use (Apple, Microsoft). However, other than conviction bets (companies you know/believe will do great), I advise you to own a diversified, low cost, portfolio of stocks through ETFs and indexes. I cover this here.