Cy Lynch tells you all that you need to know to beat the averages in the stock market and have fun doing it.

Why Invest in Stocks?

By Cy Lynch

These days, more and more people are looking seriously at their long term financial health. Concern over the viability of Social Security, changes in company pensions, desires to provide a college education for our children, separately or together, all have raised interest in investing. Successful investing is not difficult. As Peter Lynch said:

"Any normal person, using the customary three percent of his brain, can pick stocks as well or better than the average Wall Street expert."

(One Up on Wall Street, Simon & Schuster, New York, New York, 1989) To do so, however, you need a good plan and the discipline to stick with it.

In this column, I will set out a common sense approach to investing that can be used by anyone willing to put forth a reasonable amount of effort to learn it and how to use its tools. The plan is straight-forward: invest regularly in well-managed growth stocks purchased at a good price and hold them for the long term.

The first question you may have is, "Why Stocks?" Simply stated, stocks are the best way for ordinary people, like you and me, to make the most money on our investments.

There are two broad categories of assets. The first, tangible assets, are things you can actually see and touch such as real estate or collectibles. The second, intangible assets, are things you can't touch. Instead, they are legal rights to something. These include rights in tangible assets, such as a partnership interest in real estate. Intangible assets also include rights in a business, such as stocks. Another example is a right to receive money, such as a bond.

Some investors have significant money in real estate or collectibles. Doing so is beyond the capabilities of most of us, however. Most of us lack sufficient knowledge to assess the future salability of a collectible. Few of us have the time, energy and expertise needed to buy, manage or sell real estate. Thus, intangible investments remain as the potential best way to earn money for the future.

Three principal intangible assets are stocks, bonds and "cash" (money market funds and US Treasury Bills ["T-Bills"] are examples of cash investments). Many people consider stocks to be the most risky of these three investments and consider cash the least risky. In their mind, bonds fall between the two. That isn't necessarily true. It really depends on how you define risk and how long you intend to hold your investment.

In his book Stocks for the Long Run, Jeremy Siegel looked at the historical performance of stocks, bonds and T-Bills from 1802 through 1997. Over that time, stocks returned an average of 8.4% per year, bonds returned an average of 4.8% and T-Bills ("cash") returned 2.9%. Since 1926, the returns on each asset type have been higher, but the relationships are still the same. From 1926 through 1997, stocks returned 10.6% a year, bonds 5.2% and T-Bills 3.8%. Clearly, stocks have done much better on average than either bonds or cash in the past. There is no reason to believe that this will change in the future.

Some feel that stocks are "too risky," more like gambling than investing. That can be true if you don't follow a disciplined approach. There are several things that you can do to manage your risk many of which we will discuss in the upcoming months. For now, remember that there is no gain without risk. Even getting up in the morning involves risk.

One way to manage risk is to put time on your side. There are several ways to evaluate investing related risk. One way is called "worst case" analysis. In other words you assume the worst that can happen with each investment and scenario and rank the investments with the riskiest having the worst potential "worst case" outcome and the least risky having the best "worst case" outcome.