Stock Market Investing

Stock market investing creates a dilemma that every investor must face. As the best performing asset class historically, 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. The financial crisis of 2007-2009 has provided us with a painful reminder of this. 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 hands. 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.

How to Be Successful in 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 it 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 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.

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 has since lost over 60% of its value and substantially underperformed the general stock market.

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