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Don’t Invest In The Stock Market

We are led to believe that the best place to invest our money is in the stock market. Low barriers to entry, low barriers to exist, plenty of information, high probability of success in the long run and a lot of success stories. We also hear some of the horror stories of people who day traded tech stocks in the early 2000s, gamblers who lost it all on penny stocks, and all the chop shop, pump and dumpers like in the movie Boiler Room [3]. However, through it all, we’ve been taught, over and over again, that if you buy for the long term, you will always win.

For today’s Devil’s Advocate [4] post, we’re going to break down the stock market and show why we really are just little guppies hoping not to get eaten by the sharks.

You Have No Advantage

In the stock market, the average investor has absolutely no competitive advantage over other investors. I’ve always said that you need an advantage to succeed [5] and most of us don’t have one in the stock market. The traders on the floor have the advantage of seeing up to the second activity. The traders on Wall Street, even if they aren’t on the floor, may have a network of contacts in the media, may know other analysts in other brokers (or their own), or have good relationships with company employees so they can get a slight edge in information. Whatever the case, they have an edge you and I don’t.

Is it a make or break edge? Sometimes, yes. Most of the time, no. I liken it to playing a sport without knowing how much time is left on the clock. It won’t make or break you but in the long run, but occasionally the clock will run out on you or you’ll shoot too early. Either way, it’ll hurt and the stock market is a long run type of game.

Buy & Hold is not a Complete Strategy

If you’ve done any reading of stock market investing, you’ll know that all the introductory texts talk about the idea of buy and hold. They warn against trading and they suggest that you diversify. The basic stuff is pretty straightforward and it’s appealing to follow and write because it’s simple. However, buy and hold only gives you one direction to win and stocks move in two directions.

The point of this reason isn’t to slam the buy and hold idea, I think it’s valid as long as you have a long time to hold. The reason I bring it up is because all too often we stop here and thing we’ve accomplished the mission. Stock market investing is very involved and if you stop at buy and hold, you leave yourself open to a lot of risks.

If in the last two years you had a trailing stop loss [6] and you were nearing retirement (or whenever you’d need the money), you could’ve saved yourself some money by selling. Buy and hold until the bitter end may seem honorable but the only person benefiting is the guy shorting your shares. 🙂

Actively Managed Funds Suck

It’s a well known fact that the majority of actively managed funds don’t beat their benchmarks but many of us are forced into actively managed funds in our retirement accounts. Why? Brokers don’t make much off index funds! Both of my former 401(k)s offered a mix of actively managed mutual funds with fairly reasonable expense ratios (they were all under the industry average). Neither, to my knowledge, offered index funds, the cheapest mutual fund options available.

Saving for your retirement is important and it’s great that vehicles such as 401(k)s and IRAs exist, but ever wonder why, in most cases, you can only invest in the stock market?

Insufficient Analysis

Finally, most of us don’t do nearly enough analysis of a stock or a mutual fund before we buy it. It’s because it’s not our passion. Do you really want to pore through income statements and discounting cash flows based on your expected return? What about calculating the return on equity for the last five years and using that to project a price target in X years given the current P/E ratio? While those were mouthfuls of sentences, they are actually quite basic calculations to do. Now imagine doing that for all the stocks you were considering investing in (after whatever filters you applied using stock screeners) as just a starting point to know how much to pay for a share.

Asleep yet? That’s because most people don’t care enough and if you don’t care, you can’t succeed. Most of us would rather pursue our hobbies or spend time with loved ones, so we put it into actively managed mutual funds that suck. Or we go into index funds (my choice) because then we get the benchmark. Either way, we don’t do even the most rudimentary analysis required so we shouldn’t be in the game at all.

I’d love to hear your thoughts on this as the stock market is one of those very polarizing topics. Many fortunes have been made and many retirements have been secured through the stock market, but I think people are thinking differently after the economy punched the market in the gut (or lower!) last year.

Please let me know what you think!