When fiascos like the Enron bankruptcy, auditing scandals
and analysts' conflict of interest occur, investor
confidence can be at an all-time low. Many investors are
wonder whether or not investing in stocks is worth all the
hassle. At the same time, however, it's important to keep a
realistic view of the stock market. Regardless of the real
problems, common myths about the stock market often arise.
Here we go over these myths in order to bust them
1) Investing in stocks is just like gambling.
This reasoning causes many people to shy away from the stock
market. To understand why investing in stocks is inherently
different from gambling, we need to review what it means to
buy stocks. A share of common stock is ownership in a
company. It entitles the holder to a claim on assets as well
as a fraction of the profits that the company generates. Too
often, investors think of shares as simply a trading
vehicle, and they forget that stock represents the ownership
of a company
In the stock market, investors are constantly trying to
assess the profit that will be left over for shareholders.
This is why stock prices fluctuate. The outlook for business
conditions is always changing, and so are the future
earnings of a company
Assessing the value of a company isn't an easy practice.
There are so many variables involved that the short-term
price movements appear to be random (academics call this the
Random Walk Theory); however, over the long term, a company
is only worth the present value of the profits it will make.
In the short term a company can survive without profits
because of the expectations of future earnings, but no
company can fool investors forever - eventually a company's
stock price can be expected to show the true value of the
firm
Gambling, on the contrary, is a zero-sum game. It merely
takes money from a loser and gives it to a winner. No value
is ever created. By investing, we increase the overall
wealth of an economy. As companies compete, they increase
productivity and develop products that can make our lives
better. Don't confuse investing and creating wealth with
gambling's zero-sum game.
2) The stock market is an exclusive club in which
only brokers and rich people make money.
Many market advisors claim to be able to call the markets'
every turn. The fact is that almost every study done on this
topic has proven that these claims are false. Most market
prognosticators are notoriously inaccurate; furthermore, the
advent of the internet has made the market much more open to
the public than ever before. All the data and research tools
previously available only to brokerages are now there for
individuals to use
Actually, individuals have an advantage over institutional
investors because individuals can afford to be long-term
oriented. The big money managers are under extreme pressure
to get high returns every quarter. Their performance is
often so scrutinized that they can't invest in opportunities
that take some time to develop. Individuals have the ability
to look beyond temporary downturns in favor of a long-term
outlook
3) Fallen angels will all go back up, eventually.
Whatever the reason for this myth's appeal, nothing is more
destructive to amateur investors than thinking that a stock
trading near a 52-week low is a good buy. Think of this in
terms of the old Wall Street adage, "Those who try to catch
a falling knife only get hurt."
Suppose you are looking at two stocks:
XYZ made an all time high last year around $50 but has
since fallen to $10 per share
ABC is a smaller company but has recently gone from $5 to
$10 per share
Which stock would you buy? Believe it or not, all things
being equal, a majority of investors choose the stock that
has fallen from $50 because they believe that it will
eventually make it back up to those levels again. Thinking
this way is a cardinal sin in investing! Price is only one
part of the investing equation (which is different from
trading, whch uses technical analysis). The goal is to buy
good companies at a reasonable price. Buying companies
solely because their market price has fallen will get you
nowhere. Make sure you don't confuse this practice with
value investing, which is buying high-quality companies that
are undervalued by the market
4) Stocks that go up must come down.
The laws of physics do not apply in the stock market. There
is no gravitational force that pulls stocks back to even.
Over ten years ago, Berkshire Hathaway's stock price went
from $6,000 to $10,000 per share in a little more than a
year. Had you thought that this stock was going to return to
its lower initial position, you would have missed out on the
subsequent rise to $70,000 per share over the following six
years
We're not trying to tell you that stocks never undergo a
correction. The point is that the stock price is a
reflection of the company. If you find a great firm run by
excellent managers, there is no reason the stock won't keep
on going up.
5) Having just a little knowledge, because it is
better than none, is enough to invest in the stock market.
Knowing something is generally better than nothing, but it
is crucial in the stock market that individual investors
have a clear understanding of what they are doing with their
money. It's those investors who really do their homework
that succeed
Don't fret, if you don't have the time to fully understand
what to do with your money, then having an advisor is not a
bad thing. The cost of investing in something that you do
not fully understand far outweighs the cost of using an
investment advisor
Conclusion
Forgive us for ending with more investing clichés,
but there is another old adage that is very much worth
repeating: "What's obvious is obviously wrong." This means
that knowing a little bit will only have you following the
crowd like a lemming. Like anything worth anything,
successful investing takes hard work and effort. A partially
informed investor is about as effective as a partially
informed surgeon; he or she will only hurt themselves and
those around them
