26 May 2015
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You may have heard many stories about investing in the stock market.
Friends, relatives and colleagues may happily tell you their views, which can often be formed from their own individual limiting beliefs picked up from media, bad experiences or poor decision making. It is these very beliefs that are projected on to you that can dampen your motivation to explore the opportunities available to you that the stock market may hold.
These beliefs or ‘myths’ exist in people because all investment carries an element of risk. The risk is that you get back less than you originally put in, or in extreme cases, nothing at all. There is no crystal ball, no guarantees and no short cuts.
You won’t hear many people that work in finance say this. Yes, it is dangerous. It is especially dangerous for the uninitiated, the unknowledgeable and anyone with a gambling approach. But it’s not life or death dangerous, yet it can sometimes feel that way.
This is because we human beings don’t like risk. In evolutionary terms risk would equal danger, and that danger could be a Saber Tooth Tiger waiting to pounce. While we no longer have to look over our shoulders for Saber Tooth Tigers, any situation that involves risk will trigger the same parts of the brain that is concerned with self-preservation.
So it feels scary. The uncertainty is difficult to deal with; so many people avoid this discomfort completely by not getting involved, despite there being no mortal danger. Unfortunately this often leads to people repeating these beliefs to others in order to justify this fear to themselves, which over time become widely held in a population to the extent that they don’t hold the truth and become a myth.
The stock market is no different. There are many stories, beliefs and fear associated with it. During my career I’ve heard a whole host of reasons why people are fearful of investing. Some reasons are justified to a point (after all a bit of fear is actually healthy as it stops you from wild speculation and poor judgement), whereas others are wholly inaccurate.
So I thought I would summarise the 3 most common myths that come up time and time again, attempt to explain what I feel are the reasons behind them and suggest an alternative way of looking at these.
I’ve found this to be the most commonly-held belief. This causes many people who are on the fence to avoid moving forward. But let’s understand exactly how the stock market is fundamentally different from the gambling shop.
Gambling is a zero-sum game. Money is exchanged from the loser to the winner, and this process is repeated. Gambling by definition is the playing of a game at a chance to increase one’s money.
Investing by definition, is putting an amount of money to use, in something which can offer a potential profitable return and therefore investing into stocks offers you the potential for wealth generation. It gives you part ownership of a company. You own a physical share of the company in which you invest in. You have shareholder rights and can benefit from dividend payments (payment to shareholders from a company’s profits).
Unfortunately stocks can be seen as a trading vehicle or for those people who have the ‘in and out’ mentality of short term speculation, no doubt fuelled by claims that you can make “£1 million a year in your pyjamas” often touted by stock market training companies. This takes away from the fact that many people use the stock market to strategically buy stocks to generate wealth.
Investing can be considered a skill. A skill honed through a series of fundamental, technical or a combination of investment reasons. The skill of investing lies in your ability to buy and sell these stocks at the right time, balance your portfolio with suitable asset allocation, whilst using proper risk and money management strategies.
It’s not gambling. It is educating yourself about markets, companies and how to structure your portfolio. It’s forming a strategy or plan that you execute consistently. It’s having the discipline to follow this plan in the face of market movements, losses (and they will happen) and uncertainty.
I hear from a lot from people who are unsure whether investing in the stock market is for them, even seasoned investors can be nervous of making a move because the potential outcome is uncertain. This is understandable, as you want to know what you are getting in to!
It can seem true on first look at the numbers flashing across news screens, strange terms used to describe the markets and a flow of credible sounding ‘experts’ in the media who do little but overcomplicate and confuse a situation using language only they understand.
While this may appear only the domain of ‘experts in the know’, a lot is because they want to keep it that way. It is perfectly possible to educate yourself on the basics, construct a portfolio with a clear objective and manage this yourself.
But in my experience most people don’t do this.
Now, I’m going to stick my head out here and suggest that a primary reason they don’t is because they are uncomfortable with uncertainty and ignorance, which leads to a fear of embarrassment. This is what I’ve observed numerous times, especially if someone is successful in other areas of their lives such as business.
I find this frustrating as truthfully there is no such thing as looking silly or even a stupid question when it comes to investing. It can be complicated. There’s lots of confusing jargon. Many people spend their entire careers learning and then dedicate this to helping others understand. I actually consider a client more competent if they ask me questions, even ones they may feel embarrassed about, as it shows that they want to understand how things work. I love working with educated clients, and part of my role is doing so, though I can’t educate when I don’t know the questions!
There are also elements of both trust and control that you must invest and give up respectively if you accept this and use a professional advisor. This is also difficult for many people as they may not have anything to compare against. Understandable, though avoidable by comparing different providers, doing your research and talking to someone with experience of dealing with them.
As a result, this can lead to people just ‘making do’ with the low interest rate returns in the likes of bank accounts or a cash-only ISA.
It is actually really simple to invest in the stock market. Almost anyone can purchase a stock or open a trading account and place a trade the same day. What tends to catch people out is that they mistake simple for easy. Mistakes start to mount up in the accounts of those investors who have enjoyed the simplicity of the mechanics of investing, without learning how it works.
Investing in companies with a level of capital beyond what you may be comfortable risking, not understanding how a financial product works or not understanding the concept of risk (that you should not risk what you could not afford to live without) is what separates the beginners from the experts.
So rather than dismiss the stock market altogether, why not do your own research, learn what makes it tick and make your own decision on whether it is for you or not?
Again, one of the most destructive thoughts to the unseasoned investor can be to believe this myth.
There is an old saying in the stock market – “those who try to catch a falling knife can only get hurt”. This is a reference to those that attempt to buy stocks when the price is falling as they believe they will come back. The falling knife is a rather graphic illustration of what tends to happen to these people, I won’t spell it out but I’m sure you get the picture.
This myth or belief can be devastating to an account or portfolio. A stock that has fallen in value from where it once was does not necessarily represent great value, just because the price is lower. There are countless examples of once great companies which have been great performers in the past have been brought down in price over time due to the inability to turn around the reason which was making it fall in price – some of these giants have not returned to date.
I’ll explain with the example of Kodak. Forgive the fact this is a US listed company, but I feel that this gives the clearest illustration of this in recent years.
Once a leading American blue-chip company, a giant of the photography industry and a household name, Kodak enjoyed years of prosperity while the technology it made and sold was the best in the business. There was a strong demand, the market that it served used what they sold almost habitually and they had a global brand, which made it a valuable company.
In recent years however it has been struggling. The change in industry trends, consumer behaviour and innovation in the digital space meant that Kodak’s competitors and new entries into the market ate away at its market share.
To quantify the damage done to the value of the stock, the first ten years after the turn of the century saw Kodak’s share price fall from $64 to $39. Our amateur investor who is unaware of the companies’ challenges may have seen this as a great chance to buy in, expecting the price to return to near its previous highs. Unfortunately for our eager investor, buying in to this would have resulted in them losing money on a consistent negative downturn from 2001 to 2010.
This situation hasn’t improved much since. At the time of writing Kodak’s price is sitting at $18, having filed for bankruptcy in 2011, which they came out of in 2013. It’s a valuable lesson to learn from the outside, but a painful one if you were involved.
Kodak still has a recognisable name, yet the fundamentals of the business and the industry in which it operates changed, making the company’s products and services less relevant to a different world, set of demands and customer base.
This all had a negative impact on the value of the company, yet if you ignored this and just looked at the price of its stock in comparison to where it had been in the past, you may have been seduced into thinking that it will see that price again. It may or may not, time will tell, but if it does Kodak will need to work very hard to claw back the market share it lost by burying their head in the sand and ignoring the reality of the changing market dynamics in which it operates.
A pretty good illustration for our theme! This is not to say that a company like Kodak can’t turn around.
But lets put some numbers to myth No. 3 and really understand what’s going on, let’s consider these two hypothetical examples:
Which would make the best buy? Amateur investors tend to focus on where Company A once was and then buy into it, using hope or a false belief that it will go back to its previous price as their main motivation to see those levels again. There tends to be more fear around Company B as no one wants to ‘buy at the top of the market’. So they ignore the fundamentals and positive news flow, instead deciding to invest in a ‘bigger, more stable’ company they know and understand.
What you could do, is to invest in companies at a reasonable price and consider the reasons why the price is where it is now. Buying companies because the market price has fallen back recently, (this concept should not be confused with value investing – buying high quality companies that are undervalued in accordance to the market) – see our recent post on price vs value to explore this further.
So there you have it, three of the most commonly heard myths I hear about the stock market. There are many more which I hear and are unwritten here – perhaps I should write a collection of some others a bit further down the line? Let me know!
What were some of your initial investment hang-ups before you started? Or what are some of the concerns which you still have? Let me know in the comments!
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