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The stock market is a strange place for many. It is surrounded by many myths. And if you are not careful and believe in these myths, you may well end up losing a lot of money. Some of these myths make people not want to invest in the stock market. As such they are losing a nice opportunity to invest their money.
Some of these myths came from the early stock market where it was indeed more difficult to start investing. However, many things are not true anymore and some things that were facts long ago are now myths.
It is important that you do your own research. And it very important that you base your investing strategy on facts and not myths. For this, it is very interesting to go over the myths to make sure you do not fall for one of them.
In this post, I am going to list the 13 biggest myths of the stock market.
1. The Stock Market always Go Up
You have probably heard this one a lot: You should invest in the stock market, it always goes up. This is a big fallacy.
It is true that the stock market historically went up on average. This means that over a long period of time, the stock market always went up. But there were many periods of time where the market goes down more than 10%.
If you want to invest in the stock market, you need to be prepared for big drops. On average, the stock market experiences a 10% decline at least once a year and 20% drop about every four years. And you should be ready for a steep drop of 30% once a decade.
2. Investing in the stock market is for the rich
Many people are not investing in the stock market because they believe that this is only for the rich.
This is completely wrong. This is probably one of the oldest myths. You do not need a lot of money to make money in the stock market. If you invest 100 USD or 1000 USD in the same portfolio, you will have the same returns in percentage. Of course, in absolute values, the more money you have, the more returns. But that is not preventing you to invest with little money.
It is true that some mutual funds have some minimum like 5000 USD. But you can always use a broker and buy a single share of an Exchange Traded Fund (ETF) for a few hundred dollars. There is really no need to get rich before you invest in the stock. On the contrary, if you wait until you get rich before you invest, you may well never invest.
The best time to invest is now! You can invest in the stock market with little money!
3. Investing is gambling
Some people do not invest because it is too risky, like gambling.
It is true that if you invest in some single stock, you will have a very risky investment. If you invest in a good company, you still have better odds than playing against the house (gambling). But investing in some shady company could indeed be compared to gambling. But investing in the broader market is not that risky. Over the long-term, you can have really good returns.
Of course, there is no guarantee and no investment is risk-free. As we mentioned with Myth #1, you can expect the stock market to drop by 30% at least once per decade. But you just need to be strong enough to not sell and wait for the next recovery. It may take a long time, of course. But this is all part of investing.
4. It is easy to beat the market
Many people believe they can beat the returns of the market. They often believe that because some investors and fund managers beat the market for some years.
However, when you study the returns of all the active funds against the returns of the broader market, you can realize that in the long-term, none of these funds outperformed the market. In fact, most active funds significantly underperformed the market in the long-term.
This is the main reason why passive investing is so popular these days. You invest in the entire stock market instead of betting on some stocks that will then beat the market. Of course, that is not without risks either. And you still have to do some research. For instance, you have to choose into which index you want to invest. However, with this, you are guaranteed the returns of the market, minus some fees. And you will want to minimize these fees.
Stock-picking pros are not stupid. They are just expensive -John Bogle, founder, Vanguard
5. A stock that has gone down will go up
This myth has always been around I think. Some people are investing heavily in some stock that is going down because they believe (they think to know) that it will go back up. They base this on the fact that it was going up before so it should continue to go up.
Now, some stocks will indeed recover. A good stock that is going down may be available for a premium. However, a bad stock going down may simply indicate a direct slope without recovery. Even in the case of a good stock, nothing indicates that the stock was not simply overvalued before. So, there is absolutely no guarantee that a stock going down will go up again.
Now, if you believe in the fundamentals of the stock you are buying, or in the index, you are investing in, you may want to continue investing a premium. This may bring your average price down and may increase your returns in the long run.
There is another version of this myth: One stock is already 90% down, there is no way it will go down further. But this is even more dangerous. If a stock is down 90%, there is probably a very good reason. Once again, it may have been grossly overvalued, it may have been hot or it may simply be a bad company. In any case, nothing prevents it to go down even further. Do not forget that a company can also bankrupt, bringing the share price to zero!
6. A high-priced stock will go down
The next myth is almost contrary to the previous myth. Some people that a price that is going up a lot has to go down at some point. And they are waiting for the drop to invest.
This is pure market timing. And this is far from being true. Some stocks have been going up for a long time now without showing a sign of decline. For instance, Walmart stock has been going consistently for a very long time. It went down with the market correction and recessions but did not encounter a correction of its.
As we can, the price of Berkshire Hataway (BRK.A), the company of Warren Buffett, never went down as much as some investors would have wanted. Some people waited on the sidelines for a very long time. And doing so, they lost a lot of returns.
Of course, that is not to say that some stocks will never go down. But if you believe in a company potential to grow, you should invest right now, not wait on the sidelines forever.
7. Bonds are always safe
Many people believe that bonds are entirely safe.
But this is not entirely true. They may be safer than stocks in some situations. But sometimes, bonds are actually riskier than stocks. The problem is that most people do not understand bonds. People understand the yield, but they do not understand how they are valued.
When you buy a bond, you get a guaranteed interest rate over some period of time. If you keep the bond to its maturity, you will have regained your capital plus some interest. However, if you get a bond from a company, it may default on its bond (think bankruptcy). If you invest in government it is much less likely to default, but it is still possible. In case of default, it is unlikely that you get anything in the end.
However, the current value of a bond will change if the interest rates are raised or lowered. If the interest rate rises, your bond will be worth less. On the contrary, if the interest rate lowers, your bond will be worth more. That means that the value of a bond is not fixed. Moreover, the price of bonds can also change as more people or fewer people are interested (offer and demand!).
In the short-term, bonds are indeed less volatile than stocks. However, in the long-term, they may be more volatile.
8. A good company always has a good stock
This is a myth that is dangerous to follow.
Generally speaking, it is true that a good company has a good stock as well. However, there is one big case when it is not the case. Sometimes, the price of a stock can be grossly overvalued.
The best example of this is for many Technology stocks during the dotcom bubble. For instance, Microsoft saw its share drop 50% after the dotcom crash. It took about 15 years for the stock to go back to its dotcom level. But Microsoft continued increasing its earnings all along. Another crazy example is Verisign (VRSN). The dotcom crash made its stock price drop from 250 dollars to less than 10 dollars. Since this day, the stock price has not yet recovered. But the company is doing great. All these companies were simply highly overvalued.
Sometimes, a good company that is highly favored by people can perform worse than a worse company that is not liked that much by people.
9. Higher Risk means Higher Returns
The myth that higher risk always means higher returns sounds like it makes sense at first. However, there are many cases when a higher risk does not make higher returns. We are here talking about the risk in different stocks.
This is a good theory but it does not work in practice. Times and times again, it has been shown that on the long-term, investing in low-risk stocks yields higher returns than investing in higher risks ones.
Another way to look at it is to look at the best investors in the world. For instance, if you look at Warren Buffett portfolio, you will not see risky assets. You will see assets that have high value but were undervalued in the market.
Another problem is that sometimes some shares have higher returns, but it may not last. Emerging Markets performed very well from 2000 to 2007. But they then crashed and have not yet recovered to this day. In the last decade, they have returned almost zero returns. But still many people are using them to increase the yield of their portfolio.
10. You need to be a genius to invest
Many people do not invest in the stock market because they think they are not smart enough for it. They think that investing in the stock market is for geniuses.
This is a really old myth. But this is still only a myth. You do not need to be extremely smart to invest in the stock market. You need to be in control of your emotions. Your emotions can a huge problem when you invest, much more than your intelligence.
If you invest only in broad indexes such as an index for an entire country, there is no need to be very smart for it. You need to not invest too much money of course. And you need to not to sell at the first sight of a loss.
This myth is also often related to age. Some people think they are too young or too old to invest in the stock market. But there is no correlation with age and the ability to make money on the stock market.
11. A market drop makes you lose money
This myth is all over the news and the media. If the stock market drops 10%, all the media outlets will say that people lost 10% of their money. They will that people lost billions of dollars.
But this is completely wrong. You do not lose money if the market is dropping. The shares that you have in the market are worth less after the drop, that is true. But if you do not sell them, you have not lost any money. You can only lose money on the market if you sell some shares. As long as you hold onto your shares, you can still hope for a recovery.
The reason this is all over the news is that fear sells well. People are very quickly afraid about these things and the media use their fears to sell more news. This is a bit sad but there is nothing we can do about that.
Only sellers are losers! People that do not sell during a drop, do not lose money.
12. You should invest in what is hot
A myth that has also been around for a long time is that you should invest in what is hot right now. This is also known as following the crowd.
But following the crowd is one of the biggest mistakes you can do when investing in the stock market. However, there are a few problems with this approach. The people who invested early may make a lot of money with this. However, all the followers are already much later into the game. This will diminish the possible returns of the stock.
Moreover, often, the price of the stock will be driven madly simply by all the people following the crowd. They are all thinking the price will go up forever and most of them did not do any analysis of the stock. When the early investors are going out and selling, the price is likely to fall. At this point, investors get scared and start selling really quickly. This leads to an even quicker descent and ends up in a big correction for the stock
You should never follow the crowd. It is best to ignore as much as possible of financial advice and do your own research.
13. Every IPO will make you rich
These last few years, we have seen a lot of Initial Public Offering (IPO). There is a belief that every IPO will return a lot. But that is a myth.
The big problem with that myth is that most of the IPOs we hear about are the successful ones. We do not hear as much of the failed IPOs. But there are more failed IPOS than there are successful ones.
Most recently, everybody was excited about Uber IPO. They started the IPO at 45 dollars, but the first day ended up at 38 dollars. It took about one month, in a market going up, for Uber to trade around its IPO price again.
The problem with IPO is that they often lead to big overvaluation. The IPO price is often much higher than the real value of the company. Shareholders just hope for investors to invest because of a trend, not because of the value of the company. And the time of the opening can also be crucial. If one IPO starts on a very bad stock market day, it is unlikely to trade very high.
As you can see, there are many myths surrounding the stock market. If you believe in these myths, you may do many investing mistakes. You should be careful and learn about these myths in order to save yourself some big mistakes.
I think the worst myths are the one that blocks people from investing in the stock market. For instance, there are many people that believe that they need thousands of dollars to start investing or that they need to be genius. This prevents people from investing their savings.
It is important that your investing strategy on strong facts instead of things that people believe. You should be skeptical when you read things about the stock market. Do not let myths hinder your stock market investing!
What about you? What stock market myth did you believe in? Do you know any other interesting myth?