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Your Take: Faith in the Stock Market

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Game of LifeHere’s what every stock market expert will tell you – slow and steady wins the race. Keep your regular contributions going, lean on the benefits of time and compounding, and you will be financially set when you retire. Ignore the daily swings of the stock market, those are based on the whims of traders and market makers, just keep at it and you will be just fine. Statistics will be quoted, including the infamous “the stock market has returned XYZ since 19-whenever,” and those are supposed to buttress the argument that the stock market is just fine… as long as you ignore the daily gyrations.

Here’s the problem I have with that line of thinking – the market may have offered a reasonable rate of return since the Great Depression but a lot has changed since then. With the sheer number of electronic trading, including emotionless computer algorithms that follow their independently programmed instructions, and events such as the flash crash, it’s obvious we aren’t in the same era as before. High frequency trading accounts for almost 75% of all buying and selling of equities, according to Bloomberg.

The first arrow that pierced the sanctity of the stock market was when I read Trading with the Enemy by Nicholas Maier, which chronicled Maier working at Cramer’s hedge fund. In that book, Cramer finds out about a newspaper article before it gets published and trades based on that information. Is it insider information? Perhaps. Does this happen all the time? Very likely. Does this make you believe that us buy and holder suckers are really just buying into a Ponzi scheme?

Do I believe the stock market is the easiest way for you to save for retirement? Yes. You really can’t beat getting into and out of a fairly liquid position for only a few dollars. When I buy shares of Apple, and I have, I’m not worried I can’t find a buyer in the next ten seconds. I might have to adjust my expectations, which should be in line with demand at the moment based on Bid/Asks, but I can find someone fairly quickly… much quicker than any other asset.

Is my faith somewhat affected by the hundred+ point swings in the market that seem to happen on a daily basis these days? Also yes.

How about you?

(Photo: psycho-pics)

{ 16 comments, please add your thoughts now! }

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16 Responses to “Your Take: Faith in the Stock Market”

  1. cubiclegeoff says:

    My frustration with the stock market is that it has become a game and has lost a lot of it’s meaning. A lot of this is due to the hedge funds and the computers that trade millions of shares just to make a cent or fraction of a cent profit per share. It’s great for those that are making the money. But I think of the stock market as a way to support a company and find a way to make a profit off of a company’s activities. The short term trading and the over dependence on quarterly results, and all the other crap has made it just another game.

    Having said that, it’s the only decent hope for most to make enough to survive retirement.

  2. Dave says:

    When I got my Finance MBA, I had a high level Finance course with a professor who called investing in the stock market a gamble and no different than playing in a casino on the first day of class. His reasoning was that so much of the daily fluctuations were based on emotion and not facts, so you invest in a stock and have it lose half its value the next day due to bad “news” when the underlying priciples of the company and its business projections hadn’t really changed. Needless to say, this really upset some of my classmates (the school in is the NY suburbs) because they actually worked on wall st, and some even got up and left the classroom, never to return.

    To counter his point, I believe that the stock market is an excellent tool for financial investment. Even though hedge funds or bulk traders try to earn tiny margins on huge volumes and cause huge swings in prices day to day, the inherent value of the companies don’t change much day to day. The companies are still creating value, paying dividends (hopefully! :)) and in the long run, the value of the collective market will increase. As long as the individual investor has diversivied their portfolio, they will capture some of that value.

    As for the market being a ponzi scheme, I disagree. The investor owns a piece of a company. The company has value, so they own a piece of that value. Now, the market may drive the price of that piece higher or lower than it is actually worth, but if the company is creating value and making more money than it spends, each share of that company increases in value, independant of the market fluctuations…

  3. Anonymous says:

    In my opinion the high frequency trading driven by super computers and the likelihood that many traders are working with an unfair advantage of insider information is actually one of the best arguments in favor of a buy and hold long term strategy. What is the alternative to buy and hold? It is usually some kind of market timing based on some fantasy or gut feeling that is driven by emotion or faulty logic. Or based on some Timing Guru’s recent success that inevitably dissipates overtime. To try and compete with the supercomputers and insiders is a losers game, often even for them. A recent study of Cramer’s picks shows that if you followed his advice over the measured timeframe he is basically harmless. He has won some and lost others for roughly market returns. But don’t forget Lehman Brothers, and the Long Term Capital Management Hedge Fund run by the “best and the brightest” that went belly up and had to be bailed out by the US Govt. in the late 90’s .

    And that is with Nobel prize winning economists and others with super star reputations running the strategy.

    Another possible alternative is to find somewhere else to invest that is outside the market. Good luck with this one; everywhere you go is driven by market pressures and risks abound everywhere. Buy real estate? You risk a big real estate crash like we are experiencing now. Put it in an FDIC savings account? You risk inflation eating up your investment. Gold? Watch out for a speculative bubble. Bury it in the back yard? Again you can be consumed by inflation.

    The only sensible way to proceed is to hedge yourself three ways.
    1. Buy leveraged real estate to protect yourself against inflation. For most of us this is our house with a 30 year fixed rate mortgage.
    2. Buy equities to position ourselves for periods of prosperity. For most of us this is stock mutual funds.
    3. Buy Interest earning investments to protect against deflation. In early stages this would be Money Market funds, CDs and carefully selected bond funds. As retirement approaches then US Treasury STRIPS.

    A balance generally for most people of roughly 1/3, 1/3, 1/3 in the above three categories and held long term with regular rebalancing is the way to go.

    All the best

    W John Dulmage CFP®, EA
    Financial Pathways
    50 Nashua Road, 112 Londonderry Square
    Londonderry, NH 03053

  4. Britton says:

    “But I think of the stock market as a way to support a company and find a way to make a profit off of a company’s activities.”

    Be aware that the stock market does not actually support the company in any way beyond the IPO. They’ve already got their capital; if you buy their stock after that, you’re just playing the game.

    As for faith in the stock market: volatility has happened before, and it will happen again. You and I weren’t investing in the 70’s, much less the 40’s, so this is all new to us.

    However, even those who were there have forgotten, for the most part. The big problem is that as humans, we’re hard-wired to ignore long-term history and believe that it will always be like it is now — “recency bias”.

    If you’re nervous, I’d recommend turning off the news for a week and (re-)reading some books by Bernstein, Malkiel, Swedroe, and the like. I’m not saying to go all out on stocks — feel free to hedge your bets by putting some of your money into bonds (slowly, over time) — but please, don’t make decisions based on the performance of the past couple years. This is precisely what leads most people to sell low and buy high.

  5. DIY Investor says:

    8/13/1979 BusinessWeek published their “Death of Equities” article with a stock certificate made into a paper plane crashing on its cover. The Dow was at 875. Today the Dow is at 11,159 – add in the dividends and do the math. Back then there was no internet, no cell phones, DNA hadn’t been mapped, and there weren’t even PCs. We hadn’t even heard of Steve Jobs or Bill Gates. The point is that every generation has an excuse to be afraid of investing in the future of America. Those that don’t pay dearly.

  6. arvin says:

    I have to admit while I’m still building my income most of my money is going first towards eliminating my student loans, keeping a strong emergency fund, and saving up for a wedding. Stocks and retirement are a low priority right now (I’m 28)

  7. TaJ says:

    I had a lot more confidence in the stock market before I started studying financial history. Now I feel kind of like someone watching a horror movie where you can yell at the screen all you want but people are still going to go in the room with the axe murderer because that’s what people in horror movies do. This time is never different.

    Which is not to say I don’t own any stocks, and don’t make money on the markets, but that’s trading – and most people don’t want to take the effort to be a trader (and it is a ton of work).

  8. kenny says:

    Wall Street is driving companies to becoming a trading vehicle. What I mean by that is that they are making each corporation a profit-loss engine that is measured monthly and at most quarterly. With such a push in the last 5-10-20 years, companies are driving decision without a 1 year plan that they stick to, as opposed to doing the 3 to 5 year planning and then executing off it. Also, the product cycles are so narrow (small), that the vision has become narrow also, and no one is taking time to slow down and measure success or failure. HP’s tablet, RIM’s Playbook (coming next) are perfect examples of it.

    My view of the market as a result is to invest in the growing economies for the long term, using DCA approach into ETFs. This means investing in BRICS or CIVETS with a huge portfolio invested in international countries (outside of US) and then invest into Real Estate in the US by buying Govt Sold properties that are priced at 1/4th the last sale price. Govt is crazy in selling these, but that will protect me against the inflation factors that are coming to hit us on the left and right side of the head, keeping us spinning for a long time.

    The soon to be $15T in debt is going to really make us deal with life somewhat like Greece and shoot up our LT Bond rates, taking the market down.

    Please consider the entire message above ‘as read here first, and it came as early as 10/2011’. I am very confident in the above and am moving funds into non-USD currencies, Real Estate and Non-US Emerging Markets (the volatility of EM is worth it since at the end of the decade it will show growth of 15% per year CAGR).

    Good luck to all of you reading my message.

    (alias KKP)

  9. Finally, someone who speaks rationally about the stock market. I’m tired of hearing “just dollar cost average and you’ll get 5% per year at least.” All those compound interest calculators are a bunch of bs. Sure, compound interest works in your favor IF the stock market continues to perform like it has in the past. But, as you point out, times are very different now, and I bet a lot of us are going to be in for a big shock one day soon when the entire market crashes and burns.

    That said, I’ve taken some more risky “long term” investments and they haven’t panned out. But even my “wiser” index fund investments are performing poorly. I even thought I could outsmart the market by investing in XLF — banking stock ETF — since my tax money is going to bailout the banks, they should clearly offer a good return, except they haven’t, I’ve lost money on my bank stocks too. Maybe things will turn around in the coming years, but a few more years of this and I’m going to start looking for other investment options, or just figure I really need to save a heck of a lot more money if I ever want to think about a real retirement.

  10. LouisC says:

    There is no free lunch. If you want more than a nominal return that does not keep up with inflation, you have to take risks with your capital. How you choose to do that is key. The stock market is not a casino. It is a partial stake in companies trying to make money.

    Manage risk by selecting a bond allocation commensurate with your age and risk tolerance, and select the location for your investments with tax efficiency in mind. Finally, focus on index funds with the lowest expense ratios, then rebalance about once per year if your allocation becomes out of balance. If you do this, you will naturally buy low and sell high based on the relative value of asset classes.

    If you stay the course, you will do better than 99% of most investors trying to beat the market.

  11. There is no faith in the market.

    Quick examples:
    – Only 202 of the 500 biggest companies in the United States in 1980 were still in existence 20 years later.
    – On December 29, 1989, Tokyo’s Nikkei stock average reached its all-time peak of 38,915.87. Twenty years later, the Nikkei has never again reached that level — and, in 2009, reached a new low of 7,054.98.

  12. JP Adams says:

    Jim. Very interesting case. I look forward to picking up Trading with the enemy to further my own understanding of how the stock market has changed since The Great Depression.

    I disagree however with the breadth of the application of your ideas:
    – 95% of people don’t have disposable income beyond retirement income to invest
    – The infusion of so much Hedge Fund Capital into the market has increased the competition. The average investor will lose if they compete.
    – Too few people invest in the 401k or retirement vehicles at all. The focus should be on increasing that participation rate.

    What do you think?

  13. Taken with a grain of salt. It’s been said at least a million times – “things are different this time.”

    If I remember correctly, didn’t you also say in 2007 that the economy was fine and that there was no chance of a recession?

  14. Fabclimber says:

    Those looking for long term gains in the market better watch out. Boomers are reaching 65 at over 10,000 per day and that will keep happening for 19 years!. They will be moving lots of money into fixed investments for safety. They will be withdrawing many billions per year out of the market to live on. Much more than new money coming from the remaining workforce. They will have to cut way back on spending too.

    This can only drive values lower and lower. They will all be selling. Who will be buying into the marketat that pace or greater?

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