Maybe you’ve read my previous articles and are convinced that investing is a necessity. However, there are just a few things you have heard that are stopping you from taking that first step. This article seeks to debunk 5 myths about the stock market.
1. The professionals know better
Many think that we should leave investing to the “pros”. After all, they do this for a living, so they should know better. This thinking results in retail investors blindly follow financial advice or entrusting their life savings to fund managers. While there are indeed some financial advisors and fund managers who have our interest at heart, this line of thought is not always true for various reasons.
First, there is a conflict of interest as these advisors typically make money by selling us a financial product. Thus, they are inclined to sell us any product regardless of how good they actually are. This can be likened to asking a fruit seller if his fruits are fresh. There is a clear misalignment of interest.
Secondly, the people in the financial industry sometimes do not completely understand their products as well. Take the case of the global financial crisis for instance. Most investment bankers did not even understand the financial product they were selling due to the high degree of complexity.
The combination of a conflict of interest and poor regulatory oversight means that not everything financial “experts” say can be trusted. We must always do our own due diligence and follow up by doing more research. Have a healthy dose of skepticism, especially if the returns sound too good to be true. After all, no one else has our interest at heart more than ourselves.
Furthermore, according to a report, over 15 year periods, 90% of actively managed investment funds failed to beat the market. This means that simply dollar cost averaging monthly into an ETF tracking a broad based index beats 90% of the “professionals” that seek to beat the market. Still think the pros know better?
2. Retail investors are bound to lose money in the stock market
In our traditional Asian society, many amongst the older generation have negative impressions of investing. This is probably due to their experience during the dotcom bubble in 2000 and global financial crisis in 2007/2008, where periods of euphoria has resulted in many losing their life savings.
We have all heard many stories about people who have ruined their lives trying to make a quick buck through investing in the stock market. This makes the stock market seem like an obscure place where we retail investors are bound to lose money. In my opinion, this is one of the biggest misconception of the stock market as it merely tells half the story, painting a bias against the stock market in our minds. While it is indeed true that one can lose everything in the stock market, I would argue that this happens when people view the stock market as a mean to get rich quick, chasing high returns in short time periods and blindly following others.
A study found that using a one year time frame, the worst year experienced by the S&P500 delivered a return of -43% while the best year delivered a 61% return. As the time horizon increases from one year to 20 years, the likelihood of experiencing negative returns steadily decreases. Most notably, there is no 20 year period in which the market has produced negative returns. The worst 20 year period delivered an average annual return of 6.4%. This means that by adopting a long term outlook and staying invested in the stock market, we can enjoy the wealth creation by the stock market.
3. Investing in the stock market is akin to gambling
This is similar to the previous point. Some may compare investing to gambling, where one puts up money for a chance to win even more. This cannot be more misguided. While there are indeed some people who gamble on the stock market, proper investing requires skill, knowledge and the right temperament. It is because of these qualities of a successful investor that I find investing more like a job than gambling, where the house always wins.
The difference between investing and gambling is delineated by Benjamin Graham in The Intelligent Investor, where he defined investing as “an investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return”. Investing serves to protect our capital while providing a decent rate of return. Gambling, on the other hand, provides the possibility of a windfall but also a high chance of losing everything.
Based on the study cited in the point two, there is no 20 year period where the S&P500 produced negative returns. If investing were gambling, that seems like pretty good odds to me!
4. You need a lot of money to invest
Many often think that investing is for the rich as it is only worthwhile when you have a lot of money. This is because a 10% return on $10,000 is only $1,000 while a 10% return on $1,000,000 is $100,000. This is true but this line of thought discounts consistency and compound interest, two things that are key to successful investing. For instance, by investing $350 a month at 8% per annum, we will have more than a million dollars at the end of 40 years.
$350 is not an exorbitant amount of money that is out of reach of the layman. Yet, over a period of 40 years, it can completely change our lives. All we need is consistency, time and the right mindset.
The misconception here is that the stock market is a means to make people extremely rich, therefore one would need a lot of money to make even more money. Instead, we should adopt the view that the stock market is for protecting our money against inflation and to create long term wealth. Any little amount that we have and do not need for the foreseeable future is worth protecting and compounding.
5. You need in-depth financial knowledge to invest
When ask to picture what an investor does, many picture someone with three or four screens who spends his day analysing charts, graphs and statistical models. This impression makes it seem like one needs in-depth financial knowledge to begin investing. Furthermore, there are many jargons that simply put people off and make investing seem very technical and hard to understand. However, I would argue that these jargons are created for that very purpose, by those in the financial industry to give the general public the false impression that investing requires superior inside knowledge. This increases demand for their services. In my opinion, once you understand some basic investing principles and grasp your head around compound interest, you will find that investing is not as difficult as it seems.
Let me substantiate my argument with the story of Ronald Read. Read lead an extremely low key life. He fixed cars at a gas station for 25 years and swept floors for 18 years. He lived a frugal life, staying at the same two-bedroom house which he bought at the age of 38 for $12,000 for the rest of his life. When he died at age 92 in 2014, he made the headlines for having a net worth of $8 million dollars! This came as a shock to the world, including his friends. What is more shocking to many is that there is no secret behind it. He saved money and invested them into blue-chips and let compound interest do the work. He stayed the course and continued to do so no matter rain or shine.
The fact that someone with no financial background can amass such a huge amount of wealth is a testament to the potential of the stock market to create wealth for anyone with the right mindset.
All that being said, I have to caveat that these misconceptions are not entirely baseless. They each stem from one misunderstanding or another. What we need to have is a proper understanding of the stock market and how it works. From there, by adopting a proper mindset and sound principles, we can begin our journey to creating long term wealth for ourselves and loved ones. Want to learn about investing and the stock market? Click here to join The Dollar Sapling telegram channel!