With Federal Reserve raising interest rate so quickly for the past 18 months, it seems the U.S. economy is at a crossroad. With record high inflation and credit card debt accumulated by the public, it seems that many have not yet learnt the lesson about building wealth. Partially, this is caused by lack of financial literary education. Here are the seven most common misconceptions about financial markets among the general population.
1. Investing is like gambling: One of the most pervasive misconceptions is that investing in the stock market is akin to gambling. While there is risk involved in any investment, investing is far from a game of chance. It involves making informed decisions based on the financial health and performance of companies, economic indicators, and other market information. It's about owning a piece of a business and participating in its potential growth over time. If you are buying stocks of a company without understanding of its business and/or checking the company’s financial performance because you are dreaming about the stock price going up without you doing anything. You are gambling for sure. Many companies went public with a unrealistic high evaluation have seen their share prices slashed up to 90% during the first two years. The examples are Rivian (RIVN), Lucid (LCID), Beyond Meat (BYND) and many more.
2. It's only for the rich: Many people believe that one must have a lot of money to invest in financial markets. This is not true. With the rise of discount brokers and fractional shares, you can start investing with a very small amount of money. Most working class and middle-class people are already invested with equity and bond market via their retirement account such as 401K, 403b, etc. Their monthly contribution can be any amount of their choosing. Even with individual brokerage account that people can setup by themselves, there is no minimum balance requirement. You can easily invest $100 to $1000 every month into a variety of markets. By owning a piece of business, you can free-ride the train of excellent entrepreneurs, managers, and artists, getting rewarded while they serve their clients.
3. You need to constantly watch the markets: Some believe you need to constantly monitor the news and financial markets to succeed. While staying informed is important, long-term investing doesn't require constant oversight. If you turn on the TV, go to internet, there are tremendous of information about how the economy, market, a particular company is doing. Being smart investor is about buying great business and hold for very long time. The day-to-day fluctuation in the market is merely a reflection of the psychology of traders and investors. Assets can be sold at a premium price when there is higher demand, a discount when there is fear and uncertainty. If you happened to have bought a Tesla car before January 2023, or watched how Tesla slashed its car price by 20%, you would understand this mechanism.
4. Higher risk always leads to higher returns: It's true that risk and potential returns are often linked – but it doesn't guarantee higher returns. High-risk investments also have the potential for significant losses. Risk is defined as the probability of asset price going at either direction of up or down. Higher risk means that you have a higher probability to either win big or lose big. If you cannot stomach the losing scenario, thus do not invest with a false hope that only upside will happen. If you are investing by chance, like a gambler, Vegas or lotto would be much easier and better choice for you to throw your money away.
5. Short-term trading is a quick way to make money: Day trading or short-term trading often seems exciting, but it is highly risky and most individuals who try it end up losing money. Long-term, diversified investment strategies have proven to be more successful for most investors. Remember, only 1% traders make consistent profit. 99% traders lose money overall, and they stopped trading after a period of losing money. Short-term trading requires a lot of training, practice, and execution. You are still trading your time with money, even you made it to 1%. Having a diversified portfolio via passive investment (dollar cost averaging) can build wealth slowly but steadily over 20 to 30 years.
6. Past performance guarantees future results: This is a common belief, but it's not accurate. Just because a stock or a fund performed well in the past doesn't mean it will continue to do so in the future. Each investment should be evaluated on its own merits and potential for future growth. If you don’t know how to evaluate a business or stock, of course you would rely on analysts’ opinions. But analysts are paid professional to use certain metrics and mathematic models to evaluate business. It is still based on how much profit (or potential profit) a business can make in the future but discounted to present value. As legendary investors like Sir John Templeton and Warren Buffet once said “When most people are greedy, you should be fearful. When most people are fearful, you should be greedy.” This merely tells us to have a contrarian mindset, to look at business at its fundamental values, and buy them when they are selling at big discount. When you buy productive assets at a big discount, the chance of winning in the long-term is significantly improved.
7. Stocks that go down must come back up: This is a dangerous misconception. There are many reasons a stock price can decline, and it's entirely possible that it might never recover its previous value. You can simply do a Google search on how many public traded companies went bankrupt in the past 5 years, it will give you an idea. The recent banking “crisis” with Silicon Valley Bank (SVB) and First Republic Bank (FRC), if you had this misconception and thought you were buying their stocks at a huge discount when the price dropped 80% to 90%, you probably have learnt a big lesson.
Remember, understanding these misconceptions can help one navigate the financial markets better. You must take 100% responsibility of building your own wealth. Blindly trusting others simply because they have some titles, certificates, or connection via your trusted friends, without learning the fundamentals of investing and business evaluation, significantly increase your chance of paying a big amount of tuition one day in order to learn the lesson. If you cannot stomach the loss of your money, stop wishing and hoping, simply invest in index funds and diversify your portfolio across asset class, geography, etc, and let passive investing build your wealth for you while you do what you enjoy, or not enjoy doing, for a living. At least, when you get proper education and understand the market psychology and history of financial market with its booms and bust of bubbles, you can always sleep at night, knowing that the money you put to work is working for you.
Disclaimer: This blog is written for educational purpose only. I am not your financial advisor. This is not financial advice. If you want to learn more about investing and building wealth intelligently, go take a course at great universities, or from professionals with outstanding track records, and become an intelligent investor. God bless.
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