Stock market investing creates a dilemma that every investor must face. As the best performing asset class in history, the stock market cannot be ignored as an investment vehicle. It has outperformed bonds, commodities, real estate, and gold for centuries. Unfortunately, in order to obtain these long term returns investors have to survive periodic stock market crashes and market volatility. The financial crisis of 2007-2009 has provided us with a painful reminder of this as well as the recent activity of the VIX. If you are not properly diversified your entire portfolio can get wiped out in a bear market. Stock market investing can be brutal indeed. For the risk averse investor who wants guaranteed returns the options are many but the performance outlook is of all slim. Generally, you must accept low rates of return which often do not even keep up with inflation.
For those who can stomach the risks and invest in the stock market you should be aware that the value of your investment is out of your control. Generally accepted theory is that individual stocks are valued based on their company’s fundamentals and outlook for revenue and earnings but in actuality their value is determined by nothing less than how much someone else is willing to pay for the shares that you own at the current time. The whole system is driven by just 2 factors which are greed and fear. Unstable markets are caused by an overabundance of one of these factors.
The rapid growth of discount brokers offering online trading has opened up the markets to millions of individual investors who now bypass traditional stock broker channels and buy stocks themselves in self directed brokerage accounts. Investing in individual stocks can be risky though. There are less volatile alternatives such as Index ETF’s, convertible preferred stock, and stock indices futures options trading which can be used to limit losses in a down market with the trade off of also capping some of the gains in an up market.
How to Be Successful at Stock Market Investing
Stock market investing has not been profitable for the average investor. Many studies have shown that just a small percentage of individual investors outperform long term stock market returns. Most do not even come close to matching it. There are 2 significant factors that lead to this finding. The primary is that most investors try to time investing in the stock market. They add to their holdings during Bull markets and sell during Bear markets. This Buy High/Sell Low pattern causes them to miss rebounds, which is when the most profitable investors make the majority of their money. The stock market has always bounced back from crashes and downturns, usually in an explosive manner towards the upside. Missing even a few of the best days during a rebound can greatly hamper long term investment returns. Individual’s stock market investing returns are also further eroded by trying to time the market because doing so adds unnecessary transaction fees and taxes.
Many would think the other main factor that causes individual investors to not outperform the stock market’s historical returns is poor stock picking. This is not the case however. Lack of diversification is a much greater contributing factor than poor stock picks. Investors are usually in denial about their stock picking ability. They often think their picks are above average and therefore don’t need to hold many stocks in their portfolios. Studies have proven again and again that stock picking is really just an exercise in statistics. With so many people doing it the law of averages dictates that some will excel. The few that do are then considered “market gurus” and investors flock to their methodology and stock picks. When their performance reverts back to the mean, as it always does, investors get out to chase the next hot trend and further reinforce their buy high sell low pattern. Lately, the flock haa been chasing gold on its meteoric rise to near $2000/oz while savvy investors are selling gold jewelry to take advantage of the historically high prices.
A case in point is Bill Miller, who runs the Legg Mason Value Trust mutual fund. The fund beat the market for 15 year years in a row (1991-2005), which brought him great prominence in the investment community. Many investors felt they were missing out on certain riches by not being invested in this new found Oracle’s fund and poured money into the fund as it reached its peak. The mutual fund lost over 60% of its value and substantially underperformed the general stock market. Bruce Berkowitz of the Fairholme fund took over as the best performing mutual fund manager after Bill Miller’s fall. Billions of dollars soon flowed into the fund. In 2011, the Fairholme fund flopped and fell to the bottom 5% in performance with massive outflows of investor’s money.
Learn more about Stock Market Investing
This site is updated frequently so please check back for more insights on stock market investing. Many would-be investors simply lack the capital to start. Stock brokerages offer margin borrowing to investors but only if they have collateral capital. Common alternatives to funding a brokerage account include withdrawing savings, borrowing from a 401(k), and traditional loans . Each of these have their own risks and should be well researched to determine if the potential investment gains outweigh the interest charges. Generally it is advisable to not take on debt to buy stocks. Those who do should seek the guidance of a reputable financial adviser.