Investing Series – Stocks (Part 1)

Now that we are on the right path and understand some of the basics of investing it’s time to look at the fun part of this whole deal, the part that can make you a lot of money without requiring you to lift a finger!  Investing in stocks (sometimes called equities) is a hugely complicated issue in some regards, yet can be fairly straightforward in others.  People who are much smarter than I will ever be, gain and lose billions of dollars every day buying and selling stocks.  There are complex theories and crazy computer algorithms developed to “beat the street” (the street refers to Wall Street and more generally to everyone that invests in the stock market).  There are thousands of books out there, and 24-hour news channels dedicated to telling you how you can get rich in the stock market.  With so many “experts” telling you what to do, many people, especially young folks, simply tune it out and claim that it’s too much trouble and too risky to invest in the stock market.  This prevents them from realizing their true economic potential.

“It’s The Economy Stupid” – Bill Clinton

Stocks

The idea behind the stock market is actually very simple.  When you buy stock in a company you are actually becoming an owner of a very small part of that company. That is the difference between corporate bonds and stocks.  Bonds are when you lend a company money, with stocks you actually own a part of the company you have invested in.  The stock market was set up to help companies that were successful or showed potential, get the funding they need to expand.  It is the ultimate realization of the free market.  The companies that prove themselves to be the best will attract the most investors (or so the theory goes).  This is still true to a limited extent today; however, various ridiculous complications such as derivatives and split-second trading have greatly confused the whole process.

Forget “Beating The Street” Unless You Really Want To Commit To It

I have to admit to not having decades in the stock market to speak from experience with; however, I am a self-described geek who reads and follows this stuff pretty thoroughly.  Here is my take on the stock market as it pertains to the average investor.  All you really need to know is that the stock market as a whole is by far still your best bet to grow your money.  That being said, trying to “time the market” or pick specific stocks can be incredibly complicated and is probably best left in the hands of professionals.  The fact is that even professionals get it wrong more than they get it right when it comes to “beating the street” and anyone that tells you different is outright lying.  There are a lot of different ways to evaluate stocks and if you are willing to put in the research and time I think you could possibly “beat the street” and get slightly above average results. Just realize that you are competing with some of the absolute brightest minds in the world who do this for a living 14+ hours a day, every day.

Either The Entire World Economy Completely Collapses or Stocks Will Continue To Go Up – Wanna Place a Bet?

So then, how does the average person swim in this shark tank of the stock market?  Luckily, you don’t have to try and read economic statements or do voodoo-esque technical analysis.  Instead there are a variety of ways to tap into the benefits of the stock market without assuming the risk of trying to pick your own stocks.  I’m going to share with you a few different methods that are relatively simple and straightforward, and they basically revolve around the idea of investing in a large part of the stock market as whole, as opposed to trying to “pick winners”.  When it comes to investing in the stock market as whole, the key idea to remember is that specific stocks will go up or down in a hurry quite often.  The whole stock market will go up or down by large amounts once in awhile (every few years = recessions + rally), but overall the stock market either has to go up, or the world would quit developing.  So if you believe that the world will keep growing in some capacity you are probably fairly safe investing in the stock market as a whole.  Since the inception of the stock market, it has returned over 10% per year.  Some people today claim that we should expect smaller returns in the future (I don’t agree with these people, but they raise some valid concerns) and generally, an 8% figure is considered safe.  This is still considerably higher than you can get anywhere else.

The most important thing to remember is that the stock market is usually not slow-and-steady.  It will not simply give you an 8% return on your money every year.  Instead it will go down 30%, up 40%, down 10%, up 20% etc; therefore, if you need your money in the next 5 years or so, investing in something that goes up or down by large percentages is likely not for you.  If you are looking to invest for further into the future than that, stocks/equities are unquestionably the best way to go.

Diversify and RELAX!

Now, my guess is that you have heard of many people “losing their shirt” in the stock market.  This usually happens for two main reasons.  The most common reason is that people tend to buy stocks when the stock market is at its peak because everyone is talking about how great it is and how much money they have made.  They then panic when the media starts reporting a market crash and sell their stocks near the bottom of the stock market cycle.  Obviously this is counterintuitive to the whole, “Buy low, sell high,” mantra.  The second reason is that the person bought 1-5 specific stocks (usually on advice/tips from “experts”) and those companies crashed and burned.  I can say with absolute certainty that there are ways to make sure you never lose your shirt for these reasons.  If you follow the advice I have given above, and look to invest in the market as a whole, and not just in specific stocks you eliminate one area of risk.  If you only invest money that you will not need in the next 5 years, you also make sure that you can ignore the ups and downs of the stock market and just patiently wait for historical averages to kick in.

I’m Going To Bet On The Last 200+ Years…

When people ask me, “Do you think the stock market will go up or down?” I always answer, “I know it will go it up over time, I just can’t tell you when or specifically how.”  The stock market has survived two world wars, countless recessions, the industrial, technological, and information revolutions, and anything else we have managed to throw at it.  It has grown by over 10% per year on average for well over 200 years.  I think it will be ok, but that’s just my interpretation.  As I said before, my other assurance is that unless the world completely collapses or goes to a planned economy (also known as Communism) the stock market almost by definition has to continue to rise over time.

Check in next time for a look at just how the average person can invest in the stock market as a whole and watch their money grow while they laugh at the “experts” on Wall Street who try to outthink each other.

 

About Teacher Man

TM is a self-professed nerd about all things related to personal finance. He can be found writing for My University Money, Young and Thrifty, and Canadian Personal Finance Blog. TM blogs in order to continue his quest for lifelong learning and hopefully to help others along the way.

2 Responses to Investing Series – Stocks (Part 1)

  1. Another great article Teacher man :) Yeah, there are ups and there are downs. Mr. Market as they call him is a moody guy, and you want to take advantage of him when he’s feeling sad. When he’s manic and going out of control, stay away. However, you don’t really know how sad, or how manic he can get.

    I think it was Warren Buffett who named him affectionately Mr Market. Or is it Benjamin Graham? I’m getting my PF books mixed up. :)

  2. Teacher Man says:

    Haha, it was definitely Graham. I love that example. I’ve read that 70-80% of top investors still subscribe to the simple premises of the Graham/Dodd school of investing. I have no idea if that is accurate or not, but it does seem to be the model that makes the most sense to me (I would put much more weight on it than technical analysis for example).

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