The Haunted Houses Investors Won't Enter

By Stephen D. Simpson, CFA | October 28, 2011 AAA

Depending upon your point of view, the financial markets offer either an endless variety of ways to make money or lose money. No one can follow everything, and the wise investor does not even try. So while many savvy investors have decided that they do not have the time, interest, or skills to approach certain areas of the market, others base those decisions on fear. So afraid are some investors, that they turn entire investment categories into something more like haunted houses than financial instruments.

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Gold
Writing about gold is a little like throwing meat into a hyena cage - good or bad, it's going to produce a ruckus. Few investment options seem to carry the emotional baggage of gold; its advocates often claim to own nothing else, while it detractors spare no scorn for it.

Why should investors fear gold? For starters, it produces no income. A gold mining operator like Newmont (NYSE:NEM) may pay a dividend, but gold bullion and gold ETFs like SPDR Gold Shares (NYSE:GLD) do not. While that may be a concern for investors who derive all of their income from their investment portfolios, gold is hardly unique in not paying dividends.

Gold skeptics also seem to focus on the fact that gold is virtually impossible to value. It's a scarce resource, yes (unless investors fear that alchemists are nearing a breakthrough after 2,000 years of trying), but there is no cash flow to discount, nor any earnings to assign a multiple. That uncertainty seems to give many investors fits, even though the security of a discounted cash flow or PEG model is often quite ephemeral.

Speculative Growth
If I had a dollar for every time a reader wrote to me saying that he or she "can't" buy a stock with no earnings or with a huge multiple, I would be living on an island of my own by now. Of course there are reasons to fear growth stocks. Many of these companies fail outright, and many of those that succeed never manage to live up to their peak valuations - consequently, anybody who buys in once the story is well-known and well-valued is looking for a bruising.

That may be true, but it is also true that there are few wealth multipliers that can match buying a great story in its early days and then hanging on for years to come. Berkshire Hathaway (NYSE:BRK-A), Microsoft (Nasdaq:MSFT) and Amgen (Nasdaq:AMGN) are just a tiny sampling of companies that have made millionaires out of long-term owners.

The biggest problem with many speculative growth stocks is not so much whether the company fails (failure tends to be a long-term process that gives many warnings and opportunities to flee), but the volatility that comes in the meantime. Some people really do feel poorer if their portfolio declines 5 or 10% in a week - even though they are not looking to sell and are many years from needing to access the money - and they just cannot handle the stomach-wrenching moves that go with these stocks.

Foreign Equities
It doesn't matter how many articles talk about the faster economic growth that is occurring overseas, the greater potential for capital appreciation, nor the benefits of diversification. Some investors simply will not even consider investments in foreign corporations.

According to these investors, there is too much corruption and too little government oversight overseas, so any and every company may be lying to its investors and looking to rip them off. In other cases, it's the governments themselves they don't trust - fearing that assets or enterprises could be arbitrarily nationalized or subject to punishing taxes and restrictions. Last and not least is an information vacuum - foreign companies do not necessarily publish financial results with the same regularity as American companies, and the content and format of those disclosures may be dramatically different.

Like many campfire tales, there are grains of truth here, but they are blown out of proportion. Yes, there are plenty of fraudulent Chinese companies out there, but many more that are just as upstanding as their American counterparts. Likewise, while government malfeasance is a threat, it is also a matter of perspective - investing in Germany just does not carry the same sort of risks as investing in Malawi.

It also seems like a false dichotomy to me. Enron, Worldcomm and CUC all happened "over here", and it is not as though those quarterly financial statements from American publicly-traded companies tell the truth, the whole truth, and nothing but the truth. Perhaps a Chinese solar company like Suntech (NYSE:STP) isn't for everybody, but companies like Transocean (NYSE:RIG), AstraZeneca (NYSE:AZN), Novo Nordisk (NYSE:NVO), Petrobras (NYSE:PBR) and ICICI Bank (NYSE:IBN) offer opportunities too good to ignore just because they are headquartered outside the U.S.

The Bottom Line
These are only some of the spooky manors where some investors dare not tread - other houses on this lane include options, leverage, and risk itself. Fear is not always a bad thing (it often keeps us safe), but it can build on itself and steer investors away from otherwise worthwhile investment opportunities. There is no gain possible without some risk of loss and narrowing the menu of investment options too far is a good recipe for long-term disappointment. By the same token, fear can create opportunities - if enough investors think that an industry or investment type is just too scary to even approach, that can create real opportunities and real value for more intrepid types. (For additional reading, see Haunting Wall Street: The Halloween Terminology Of Investing.)

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At the time of writing Stephen Simpson did not own shares in any of the companies mentioned in this article.

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