Debunking Some Myths About Stock Investing

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There are many myths and untrue opinions involving stock investing. It is here and I will try and dispel as many negative connotations about stock investing and hopefully, after reading this chapter, it will inspire you to continue on this path. Through doing some research on the web, I have gathered a few of these so called “truths” about investing.

“INVESTING IN STOCKS IS AS RISKY AS GAMBLING”

This is essentially the most important myth that I want to bust. Many people shun away from investing, thinking it is similar to gambling. First of all, let us look at the fundamental characteristics of both activities and you will see the differences soon enough. Gambling involves staking your money for potential profits in a game of chance where the outcome is uncertain, or impossible to ascertain. What this means is that you are essentially putting your money (savings in this case) in something hoping for a positive result but without understanding how the result can be achieved and whether the odds are in your favor.

Investing, on the other hand, refers to the allocation of capital to a product or service and expecting a return in the future while understanding the risks and factors attributing to this result. There are many different definitions of investing on the web, but this is the only definition which I would refer investments to. Any other forms of so called “Investments” are similar to gambling or speculation.
Therefore, the key difference between gambling and investing is that the investor understands the risks and factors involved in a product or service (stocks in this case) and is also able to forecast these factors with a certain level of confidence through a fundamental analysis of the company. At the end of the day, investing in stocks is similar to owning a part of a business. You have to understand the drivers as well as risks of the business and industry; identify whether strategies that the management has taken will potentially lead to a competitive advantage in the market and ultimately increased profits. This is doable with a certain level of confidence and is not as hard as it looks.

“INVESTING CAN GENERATE QUICK MONEY FOR ME”

Fundamental analysis of a company to determine the value of a particular stock, as mentioned above, takes time and effort. On average, be prepared to hold on to a stock for at least a year or two before it can realize its fundamental value. However, there are many individuals out there who buy a stock based solely on the market’s trends and investor sentiments, looking to make a quick buck by buying and selling stocks within the day or the week. They use methods such as charts and volume indicators to ascertain whether the stock is undervalued or overvalued and take a position based on this data. I do not doubt that some people make profits on these kind of strategy in the short run, but in the long run, very few people has been able to prove that stock term trading based solely on these tactics are successful. Some days you may end up earning a huge profits whereas other days you might end up losing, not to mention that every trade you make on the day results in having to pay a commission to your broker, making it even that much harder to have a decent gain in the long run. What’s more, all the stocks that you hold, since they are not based on fundamentals, could have poor underlying businesses, which means you are essentially only betting on the stock’s rise and fall based on market sentiments and not facts. Doesn’t it feel like gambling?

Investing based on fundamentals, on the other way, has been proven to be the most successful track historically. Just look at all the famous investors around the world; Warren Buffett, Peter Lynch, Templeton etc. All these individuals are shown that fundamental investing works and have an excellent track record to prove this. Why is this so? There are a few factors. Firstly, since you are essentially managing a portfolio of stocks to hold for the mid to long term, you make less trades than the short term trader, resulting in less brokerage fees, creating more upside for yourself. Secondly, you will be buying stocks with strong underlying businesses supporting the stock price, creating less volatility and more safely in your principal. All these factors has led me to believe that value investing is a much better strategy but this takes time and effort, so do not expect to make a quick buck so soon.

“YOU NEED A FINANCE DEGREE TO LEARN HOW TO INVEST THE ‘RIGHT’ WAY”

Some individuals believe only people, with a business/finance or economics degree, are best equipped to invest in stocks using fundamental analysis. Many people are intimidated by the thick annual reports and complicated terms that analysts use in their reports of listed companies. However, I can assure you that fundamental analysis of a stock is not that difficult. There are several articles on this site that will educate you on how to analyze a stock fundamentally and successfully. You do not need a finance degree to be able to understand these concepts. In fact, you will find that all it takes is a lot of common sense and intuition. Anybody can invest in stocks the “right” way. All it takes is dedication and a passion to learn.

“YOU CANT BEAT THE MARKET”

Last but not least, this myth goes on the say there are many professional portfolio managers out there who are unable to match the average performance of a global index annually, such as the S&P 500 for example. Since the professionals are unable to do it, there is obviously no hope for us mortals and we might as well just invest using a passive strategy and buying index funds. While this is true, there are many factors/restrictions that these funds have which will hamper its performances. One example is that some funds are restricted by the maximum number of shares that they can purchase in a particular stock. Therefore, many portfolio managers end up buying other stocks which might not perform as well as the intended one. Another example is that many portfolio managers are restricted to buying high profile stocks, i.e. stocks that are widely covered by the market. Why? This is because nobody wants to pick an obscure stock that is not covered and be criticized for it when it does not perform up to par. This reason can also explain why many analyst reports tend to go in tandem with each other but might not reflect the analyst’s true opinions of the stock. Also, some funds may be restricted to stocks with a certain level of market capital, which essentially means that they can only buy stocks of larger companies and we all know that the larger the company is, the harder it is to grow in terms of percentage compared to an up and coming smaller firm. All these factors do not affect the individual investor. We have the absolute flexible in deciding how many shares to purchase for a particular portfolio, have no restrictions in terms of a particular stock, be it whether it is not actively followed by analysts or is small in business size. Therefore, it is possible to beat the market.

CONCLUSION

I hope that by reading this chapter you would have gained more confidence in investing in stocks and are ready to read on to learn how to go about investing the fundamental way. Of course, no analysis is 100% accurate, but fundamental analysis of the company, by looking at the stock’s underlying business to a greater detail, is a more accurate measure of a stock’s value, rather than speculating on the markets’ trends and sentiments, which is essentially taking a gamble.

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