Chestnut & Cedar Stock Report - Equity Instruments

Equity Instruments

News Flash!

Recent studies as published in a New York Times article on 12/4/2005 titled “Aging Brings Wisdom, but Not on Investing” indicated that the stock picks of an average 30 year-old investor beats the stock picks of an average 65 year-old investor by 1.8% percent per year.

This, however, is not really a new concept. That’s why it only made page six of the Sunday Money section. Think about it; young investors take more risk, are less diversified, and have lower balances. Historically, young adults have been able to identify trends that older adults can’t envision. The old story was that in 1943 Tom Watson Sr., the founder of IBM, said: “I think there is a world market for maybe five computers.” It was his son Tom Watson Jr. who saw and capitalized on the coming trend in computers. It was mostly young adults who participated in Microsoft’s IPO on 3/13/1986, at an opening price of $21 per share. (A $21,000 investment at the IPO price, after 20 years, is worth approximately $7,200,000.) Young adults purchased Yahoo cheap; the older adults are paying top dollar for Google.

My concern, however, is that young adults, while having great ideas, are investing in equity instruments without knowing the nuances of the details involved. That aloofness can be costly. This book explains the details. My prior book “The Chestnut and Cedar Stock Report – A Guide for Investors” discusses how to pick stocks and focuses on the strategies and analysis needed in selecting and timing securities.

Why invest in equities?

Investors participate in equities because equity returns are higher then other financial assets.

Exact rate of returns are inconclusive. Studies by some of the best minds in the country, regarding the real rate of return on common stocks, over the past 50 to 100 years, are not exact. All the studies have different results; nonetheless, for conversational purposes, stocks historically outperform debt instruments. The general belief is that, over the past 75 years, stocks provided a real return of approximately 7%, while treasury bonds had a real return of close to 3%. Therefore, equity investments should return approximately 4% over treasury bonds; this is the extra that is earned by investors for taking the risks of investing in the marketplace. The extra juice that equity investors earn over fixed income returns is called the equity premium.

The Real Rate of Return is the annual return, adjusted for inflation.

Lastly, as today’s young adults get older, the trends that were discussed in the NYT’s 12/4/05 article “Aging Brings Wisdom, but Not on Investing” may also apply to them. As young investors age, “their cognitive abilities may diminish and gradually decline. This presumably affects decision-making, and may make one less capable of picking market-beating stocks.” So don’t gloat!

Remember

Please choose the subject of your interest from below or from the left side column.

- Real Estate Investment Trust
(REIT)