In chapter one of Common Sense on Mutual Funds, John Bogle makes the following recommendation on stocks: He states that based on the historical evidence, if your definition of risk is the failure to earn a positive real return (your investments outperform the rate of inflation) over the long term, then stocks are actually less risky than bonds. He says that if you believe that the economy will be healthy over the long term, then the best way to outperform inflation is the stock market.
But, you must be prepared for periods of negative returns. Sometimes over several years.
It is important to note that Bogle defines risk as an investment that does not outperform inflation. Some investors cannot stomach the ups and downs of the stock market and for them, risk is having their investment earning negative returns. Outperforming inflation does not matter to them.
Also note that he is stressing this for the “long term investor.” My advise on the definition of long term is 10 years or more. Therefore if you have need for your money in a period of less than 10 years the stock market may not be appropriate.
Finally, Bogle stresses the need to include Bonds in your investment portfolio. Bonds will generally act as insurance to your portfolio during poor stock market periods.
I will discuss portfolio allocations and risk issues in future blogs.