How can stocks benefit your portfolio? Let’s take a look.

Why invest in stocks?

Equities — more commonly known as stocks — can diversify a portfolio and help build value over time.

The chart below shows that large domestic stocks have provided an average annualized return of 10.6% over the past five decades, which is higher than the returns seen on bonds or cash alternatives over the same period.

But remember: Stocks with higher potential returns generally come with higher risk. The value of your shares will tend to fluctuate, and you may lose principal.

Are stocks good long-term investments?

The chart below shows the hypothetical current value of $1 invested at the beginning of 1970.

From 1970 through 2019, each of these investment vehicles provided the following annualized returns:

  • 4.6% for U.S. Treasury bills
  • 8.2% for long-term government bonds
  • 8.7% for overseas large-cap stocks
  • 10.6% for large-cap stocks
  • 12.2% for small-cap stocks

Clearly, stocks have a long track record of providing higher annualized returns than bonds or cash alternatives.

But during this period, all of these investments outpaced the annualized return of inflation, which was 3.9%.

Source: Morningstar Direct, 1970-12/31/2019. Past Performance is not a guarantee of future results. Calculations assume reinvestment of income and no transact taxes. This is for illustrative purposes only and not indicative of any investment. Small-cap stocks carry greater risk and have greater market fluctuation than large-cap stocks. Treasury bills and government bonds are guaranteed by U.S. government and if held to maturity offer a fixed rate of return and fixed principal value.

The above line graph shows the annual returns on the following investments from 1970 to 2019:

  • 4.6% for U.S. Treasury bills, with an ending value of $7
  • 8.2% for long-term government bonds, with an ending value of $52
  • 8.7% for overseas large-cap stocks, with an ending value of $64
  • 10.6% for large-cap stocks, with an ending value of $154
  • 12.2% for small-cap stocks, with an ending value of $312

All investments beat the annualized return of inflation, which was 3.9%. These calculations assume reinvestment of income and no transaction taxes. This graph is for illustrative purposes only and not indicative of any investment. Small-cap stocks carry greater risk and have greater market fluctuation than large-cap stocks. Treasury bill and government bonds are guaranteed by the U.S. government and if held to maturity offer a fixed rate of return and fixed principal value.


The power of compound interest

Compounding can work to your advantage as a long-term investor.

When you reinvest dividends or capital gains, you can earn future returns on that money in addition to the original amount invested.

Let’s say you purchase $10,000 worth of stock. In the first year, your investment appreciates by 5%, for a gain of $500. If you simply collected the $500 in profit each year for 20 years, you would have accumulated an additional $10,000. However, by allowing your profits to stay invested, a 5% annualized return would grow to $26,533 after 20 years, thanks to the power of compounding.1

Dividend income

Many companies pay dividends on a regular basis, most often quarterly.

Dividends can be used to supplement your income or may be reinvested to buy additional shares:

  • If you’re using this money as a regular stream of income, consider staggering your stocks’ dividend payment dates.
  • If you reinvest your dividends and buy additional shares of stock, your money has the potential to grow faster.

Keep in mind that dividends can be increased, decreased or eliminated at any point without notice.

Purchasing power protection

Purchasing power is the value of your money shown as the amount of goods or services that one unit of money can buy.

Inflation increases the cost of goods and services over time, decreasing the amount your money can purchase.

Equities offer two key benefits that help mitigate the effects of inflation: growth of principal and rising income.

Stocks that regularly increase their dividends give you a pay raise to help balance the higher costs of living over time.

In addition, stocks with growing dividends have historically provided a much greater total return to shareholders, as shown below.

The power of dividends and rising income

This chart shows that from 1972 through July 31, 2020, dividend payers and growers have outpaced the S&P 500 index and non-dividend payers in annual total return: 9.6% compared with 7.3% and 2.8%, respectively.

Source: Ned Davis Research. Uses indicated annual dividends on a rolling 120 month basis. Past performance may not be an indication of future results. The S&P 500 is an unmanaged index and is not meant to depict an actual investment. Does not include transaction costs or taxes. Dividends can be increased, decreased or eliminated at any point without notice.

Copyright 2019 Ned Davis Research, Inc. All rights reserved. Further distribution prohibited without prior permission. Data 12/31/1971-7/31/2020.

The above chart shows the annual total return from 1972 to 2020 for non-dividend payers, the S&P 500 index, and dividend growers. The smallest bar shows that non-dividend payers had an annual total return of 2.8%. The next bar shows that the S&P 500 Index had an annual total return of 7.3%. The final bar shows that dividend growers had an annual total return of 9.6%, meaning dividend payers and growers have outpaced the S&P 500 index and non-dividend payers in annual total return.

Uses indicated annual dividends on a rolling 12-month basis. Past performance may not be an indication of future results. The S&P 500 is an unmanaged index and is not meant to depict an actual investment. Does not include transaction costs or taxes. Dividends can be increased, decreased, or eliminated at any point without notice.


How Edward Jones can help

Before your financial advisor recommends a stock, it must pass Edward Jones’ disciplined analysis. We look at factors including balance sheet strength and management’s track record to assess a company’s quality. We think about past, present and future opportunities and challenges for each sector to identify the companies we believe have sustainable competitive advantages for the long term.

Then, we apply strict valuation analysis and consider any specific risks to determine a fair price for the stock. This is how we determine a buy, hold or sell recommendation. Our certified financial analysts and investment professionals challenge one another throughout the process to make thoughtful, well-informed decisions.

Our guidance can be summed up in three points:

1. Focus on quality

We filter stocks based on geography, longevity, financial risk and a company’s size before applying fundamental and valuation analysis.

Narrowing the selection

Stock selection process

Source: Edward Jones

The above chart shows how Edward Jones narrows down a list of 65,000 stocks to arrive at the list of 280 stocks it recommends. The chart features two columns: the left-hand column lists the kind of filter that Edward Jones employs on available stocks, while the right-hand column shows the number of stocks remaining after going through the corresponding filter. The chart show that:

  • Filtering by country brings the number of stocks from 65,000 to 18,000
  • Filtering by longevity brings the number of stocks down to 9,000
  • Filtering by financial risk brings the number of stocks down to 8,000
  • Filtering by size brings the number of stocks down to 750
  • Filtering by Analysis brings the number of stocks down to 280

This chart shows how Edward Jones filters stocks to arrive at the 280 stocks we recommend. The first filter we apply is country, which reduces the field from 65,000 to 18,000 possible stocks. Then we consider longevity, which reduces the field to 9,000 stocks. Our third criterion is financial risk, which narrows the field to 8,000. The fourth filter we use is size, which reduces the number of stocks to 750. From there, Edward Jones analysts narrow the field to the final 280 stocks.

Country: We consider companies primarily based in the U.S., Canada and Europe that follow familiar accounting standards and reporting requirements.

Longevity: The companies we follow need a solid track record — typically at least 10 years of operating history. This means that the company is likely to have faced at least one economic downturn and that management has experience with both adversity and success.

Financial health: We seek to exclude companies that have a credit quality below investment grade and weak financial strength.

Size: Larger companies usually have a longer track record of success, a broader base of customers and sales, and management depth. We consider companies with at least $2.5 billion in market valuation and at least $1 billion in annual revenue for coverage.

Fundamental analysis: Once companies meet the above criteria, our analysts perform a deep dive into a company’s financial and operating history and project future earnings, cash flow and a fair value of the company.

We believe paying dividends is one important measure of a quality stock. A company’s ability to raise dividends consistently can demonstrate profitability. Companies that have excess cash flow and strong financial positions often choose to pay dividends to attract and reward their shareholders. As a result, they’re often less volatile than stocks that don’t pay dividends.

But beware of reaching for high yields. A higher-yielding stock could be a signal that investors are concerned about whether the company can continue to pay its dividend. We’ve found these stocks are most at risk of cutting their dividends.

2. Diversify your stock positions

Diversifying your investment portfolio can help protect against market fluctuation. Look at the following factors as you plan to diversify:

Asset allocation: Your portfolio’s asset class mix is one of the most important factors in determining performance. Look at the size of a company (or its market capitalization) and its geographical market — U.S., developed international or emerging market.

When owning individual securities, we recommend that you consider a diversified portfolio of domestic large-cap and mid-cap stocks. For the more volatile international, emerging-market and small-cap stocks, we favor a mutual fund to help manage risk. Although diversification cannot guarantee a profit or prevent a loss, it can help smooth performance over time.

Sector allocation: Once you’ve diversified by asset class, we recommend going deeper with diversification across the major market sectors and then industry subsectors. This is because economic cycles and market shocks can affect industries very differently.

U.S. recommended sector weightings

Source: Edward Jones

The above pie chart displays the U.S. recommended sector weightings by percentage. The list, from highest percentage to lowest, is as follows:

  • Technology: 25%
  • Health care: 15%
  • Financial services: 14%
  • Consumer discretionary: 10%
  • Communication services: 10%
  • Industrials: 9%
  • Consumer staples: 8%
  • Utilities: 4%
  • Energy: 3%
  • Materials: 2%

Price movement: To help understand the risk you’re taking, consider a stock price’s tendency to move up or down relative to the market. We suggest owning a balanced mix to help smooth performance over time.

Investment concentration risk: At minimum, we recommend owning 15 individual stocks to limit overconcentration in any single stock or sector. If you’re using individual stocks as the primary way to gain large-cap equity exposure for your portfolio, then up to 30 stocks may be necessary.

3. Invest for the long term

Sticking with a long-term investment view requires discipline, and we believe you should buy investments with the intent to own them through good and bad markets. We base our investment guidance on a long-term view. For our stock recommendations, we typically use a three- to five-year outlook.

Market declines can be unnerving, but bull markets historically have lasted much longer and have provided positive returns that offset the declines.2 Also, market declines often represent a good opportunity to invest. Strategies such as dollar cost averaging and dividend reinvestment can help take the emotion out of your investing decisions.3

As the chart below illustrates, we believe no one can accurately time the market. An investor who missed the 10 best days of the market experienced significantly lower returns than someone who stayed invested during the entire period, which included times of market volatility. We recommend staying invested with a strategy that aligns with your financial goals.

Missing the best days

Value of a $10,000 investment in the S&P 500 in 1980

Source: Ned Davis Research, 12/31/0979-7/1/2020.

The above chart uses a series of bars to show how an investment of $10,000 would grow from the end of 1979 until July 1, 2020. The first bar shows that investing for that entire period would turn into $860,900. The following bars show that:

  • Missing the 10 best days would reduce the value to $383,400
  • Missing the 20 best days would reduce the value to $222,900
  • Missing the 30 best days would reduce the value to $138,900
  • Missing the 40 best days would reduce the value to $90,800
  • Missing the 50 best days would reduce the value to $61,200

How to read this chart

This chart uses a series of bars to show that from the end of 1979 until July 1, 2020, a $10,000 investment would have been worth $860,900 if invested for the entire period. Missing just the 10 best days during that period would reduce the value by more than half, to $383,400.

Time to sell: From time to time, you may need to sell a stock to help maintain proper diversification among sectors or limit overconcentration in a stock position. Significant changes in a company’s fundamentals or a stock’s valuation may also be reasons to sell. And as your portfolio’s objective changes over time, you might also adjust the stocks you own to meet income needs or match your risk tolerance.

Now that you’ve learned about stocks and how Edward Jones can help, it’s time to take action. Discuss your options with your financial advisor to find out what stock ownership can do for you.

Owning individual stocks

What is the best way to invest when you have thousands of stocks to choose from? Your financial advisor looks at the following:

  • Your financial goals
  • How much money you plan to invest
  • Your risk tolerance
  • Your desired level of involvement
  • The type of account

You can own stocks individually or through actively managed mutual funds, index funds or exchange-traded funds (ETFs). Consider the following before you buy individual stocks:

Tax control advantages4: With individual stocks, you control when to buy and sell. Individual stock ownership may reduce your tax burden.

Cost-efficiency: If you intend to hold your equity investment for a long time, buying individual stocks may be cost-effective. Ask your financial advisor for more information on the types of accounts and costs available at Edward Jones.

Customization and transparency: If you want to be involved in the decision-making process, individual stock ownership may suit you. Individual stocks offer the customization and transparency that mutual funds, index funds and ETFs generally do not. Your financial advisor can work with you to build a stock portfolio with only the companies you want to own.

Potential for higher risks: Consider the trade-offs before investing in individual stocks. The risk of losses and price volatility may be higher, especially if your portfolio is not properly diversified.

Important information:

1 Edward Jones estimates.

2 Source: Ned Davis Research, 1/1/1946-7/1/2020. S&P 500 index total return performance is for illustration only and is not meant to depict an actual investment. Past performance is not a guarantee of how the markets will perform in the future.

3 Dollar cost averaging and dividend reinvestment do not guarantee a profit or protect against loss.

4 Edward Jones cannot provide tax advice. Consult with a qualified tax specialist for professional advice on your tax situation.