Myths of Stock Market
Many investors wonder whether they should invest in stocks. But before deciding to invest, it’s important to have an accurate understanding of stocks. Understanding how to invest in the stock market is all about dispelling popular myths about the stock market.
Myths are, typically, based on half-baked knowledge and incorrect understanding of the nuances of the stock market.
Myth-1: INVESTING = GAMBLING
Benjamin Graham said that, In the short run, market is a voting machine but in the long run it is a weighing machine.”
Investing in stock market is different from speculating in the stock market. Investing in stocks may resemble gambling, but these two activities are inherently different. Benjamin Graham, the father of value investing rightly said that, in the short run, market is a voting machine(gambling) but in the long run it is a weighing machine. And investing is a long term activity.
Very often, investors think of shares as simply a trading vehicle, and they forget that stock represents ownership of the business.
A share of common stock represents part ownership in a business. It entitles the holder to a claim on assets as well as a fraction of the profits that the company generates. Gambling, in contrast, is a zero-sum game. Gambling merely takes money from a loser and gives it to a winner. No value is ever created whereas the overall wealth of an economy increases through investing. As companies compete with each other, they increase productivity and develop products that improve lives. Investing and wealth creation should not be confused with gambling’s zero-sum game.
Myth-2: INVESTING IS TOO RISKY
If investing is risky, so is swimming, crossing the road, riding a bike, and driving a car. With proper training and guidance from our parents and trainers, we learn to do these things fairly early in our lives. But the sad part is, parents rarely teach their children how to treat money – how to save and how to invest. And that’s what makes the grown up children believe that investing is risky.
Investing is risky, if…
I am not saying that investing isn’t risky. It indeed is. But only if you are ignorant about the investment subject and still try your hands at it. If you do not understand it, or if you are not properly educated on the risks involved, investing can be incredibly dangerous.
Like you will arrange a coach for your child who wants to learn swimming, in the same way you must get yourself educated if you want to learn about and pursue investing.
According to Warren Buffett , Risk comes from not knowing what you’re doing.
By educating yourself in investing, you will know what you are doing. And that will take a lot of risk away, from your investment decisions. So, investing in the stock market isn’t risky if you know how to do it the right way. What is risky is taking advice from people who don’t know what they are talking about all the time.
And the biggest risk is…not investing at all.
Myth-3: I AM NOT FILTHY RICH, SO STOCK MARKET IS NOT FOR ME
You don’t have to be a millionaire to invest in stock market.You can buy one share of ITC with only 275/- rupees. Actually stock market is the only place where you need such a low initial capital to start investing.Compare it with real estate, you need atleast few lakhs of rupees to buy a piece of land, even in a low-priced locality.
So to create wealth in stock market you don’t have to be a millionaire, all you need is to start early and keep investing consistently and let your money compound over a long period of time.
Myth-4: FALLEN ANGELS WILL GO UP, EVENTUALLY (AND) STOCKS THAT GO UP ALWAYS COME DOWN
Suppose you are looking at 2 stocks :
Stock-1 reached an all-time high of 300/- rupees per share last year, but now its trading at 90/- rupees per share.
Stock-2 was trading at 65/- rupees last year, but now trading at 175/- per share.
Majority of investors choose the stock that has fallen from 300/- rupees to 90/-, because they believe that it will eventually go back to those levels again.
This belief is only one side of the coin.
Many investors believe that just because a stock goes up, it will eventually fall.
Look at the chart above,
Asian paints was trading at 24/- in 2002, in 2019 its share price rose to 1416/-. Which means its share price multiplied by 59 X. So don’t sell a good business, just because its stock price is doubled or tripled.
If a business is well run and selling a superior product or service, eventually the value of the share will rise and so does the stock price. Conversely, if a business is poorly managed and business gets deteriorated, the share price will fall sooner or later.
So remember, just because a stock price is fallen, there is no guarantee that it will go up.In the same way, just because price of a share has rose, there is no warranty that it will fall. So, the performance of the share price will depend on the performance of business in the long term.
Myth-5: A LITTLE KNOWLEDGE IS BETTER THAN NONE
Will you let a doctor to operate on your friend or a relative, if he said , don’t worry I have a little knowledge on how to operate a heart. I don’t think you will let him operate.
Knowing something is better than nothing, but when a doctor is doing a heart surgery, it is crucial for him have clearing understanding of what he is doing. In the case of a surgery, knowing something is not enough, more over it can be deadly.
I don’t mean investing in stock market is as complex as heart surgery. Actually investing is simple (but not easy). But the individual investor should have a clear understanding of what he is doing with his money in stock market.
If you lack the time and skill to do extensive research, better take the advise of a well experienced advisor. The cost of investing your money in something, which you don’t understand will far outweigh, the cost of using an investment advisor.
Myth-6: THE YOUNG CAN AFFORD TO TAKE MORE INVESTMENT RISKS
If you are a young investor, you can survive the losses made by your dumb investments, since you have more years to work. But that doesn’t mean you can afford to lose money.
Warren Buffett 2 rules of investing:
Rule no.1 : Never lose money
Rule no.2 : Never forget rule no.1
So, according to the Oracle of Omaha, it doesn’t matter if you are young or old, you should never lose money.
But if are young, you have more years to invest, so take advantage of compounding by starting early.
Myth-7: HIGH RISK = HIGH RETURN
Suppose, you have some to invest in stocks. So I suggested you two stocks, but the catch is that, you can only invest in one stock.
Stock-1 is a cyclical business, which is making losses for the past 5-years, run by non-shareholder friendly management, facing allegations of financial fakery. If you invest in this stock, the expected return is 15%.
Stock-2 is a secular business, with durable competitive advantage(strong brand), run by shareholder friendly and honest management, this investment is also offering an expected return of 15%.
So in which stock will you invest?
Obviously, when both the investments are offering you same 15% return, you will choose the low-risky investment i.e., stock-2. The only way I can persuade you to invest in high risky investment is by offering high return.
So high risky investments will not promise you high return. In contrary, you will invest in high risky investment only if high return is offered.
In investing you will get high rewards only when you take low risks. Buy quality businesses, run by quality management, at a favorable price with enough margin of safety. So, by buying good businesses at cheap price, you are not taking high risk.
So, in investing, low risk = high returns.
Myth-8: INVESTING IS ALL ABOUT BEATING THE MARKET
Most investors measure their success or failure in terms of relative performance. It means measuring investment results, not against an absolute standard, but against a stock market index, such as Bse Sensex. Investor who try to outperform an index, may lose sight of whether their investments are attractive or even sensible in an absolute sense.
In a given year, if sensex tumbles -15% and your portfolio drops only -13.5%, you might have performed better than market, but you still lost money. Or over a period a 5 years if sensex gave a return of 9% and your portfolio managed to earn a return of 11%, again you have beaten the market, but on an absolute sense, it is still considered a poor performance.
So, instead of trying to beat the market, have an absolute performance goal. If you are able to compound your money at a cagr of 15%-18%, over a long period of time, you will create a lot of wealth in stock market.
Myth-9: FII’S ARE PILING ON TO THIS STOCK, SO I WILL BUY IT TOO
FIIs may be buying for different reasons. They might be buying just to diversify their portfolio. FIIs may be buying in one account and selling in another account. Quite often FIIs create arbitrage positions i.e. long on equity and short on futures. Buying stocks without looking at the nature of the transaction will lead you nowhere.
Myth-10: I AM ACCUMULATING STOCK ON EVERY DIP
Accumulating a quality stock at every dip is really a good idea. But buying a bad stock at every dip is a terrible idea. It is known as the sunk-cost fallacy, i.e., throwing good money at bad money. So averaging down for the sake of averaging is a bad idea, most importantly never average down a bad stock.
So instead of buying bad stocks at every dip, just admit your mistake and sell them. Forgive yourself, but don’t forget the lesson learned from those mistakes. Most importantly, don’t commit such mistakes in the future.