A lie told often enough becomes the truth, lies usually get caught when you check the facts behind them, but what if you are lied to with facts to prove them? There are many lies related to stock market, that most investors believe to be true as they are presented to you with ample proofs to convince you. I know what you’re thinking? How can one lie with proofs? Trust me, it is possible and it’s not even difficult. What are those lies and how you get lied to with proofs? Let us find out.
Diversification makes your investments safe:
It is one of the most common lies that is still believed by most investors to be true. Diversification is a strategy to spread your total investments in different stocks and sectors so that if one stock or sector does not perform, you do not lose all your money and your portfolio remains safe. It is similar to hiding your cash in different pockets, so that if you get pick pocketed, you will not lose all your cash.
While this may sound very logical approach to safe investing, it is not always true. Diversification simply spreads your risk across various sectors, it does minimize risk, but does not eliminate it. The recession of 2008-09 was the real proof that diversification is not a sure shot way to attaining safety.
When the recession hit the market, every investor, even with a well diversified portfolio lost significant amount of money. Those who diversified using different asset classes also burnt their fingers as interest rates went down to zero, in order to bail out the banks and financial institutions that were about to go bust. Safety achieved by diversification is relative, but financial advisers widely advocate it as a great safety measure against risk, which is not true.
Active investing gives higher return:
The purpose of active investing is to maximize the return on investment while minimizing the risk.The purpose of active investing is to outperform the benchmark index. Active investing requires careful analysis of individual stocks before investing and continuous vigilance (usually by a fund manager) in order to make sure that the portfolio is performing well. This may sound as a very rational way of investing, but the historical data suggests otherwise.
Analysis of historical data suggests that most of the actively managed funds fail to beat the benchmark index especially in the long run. More than of the actively managed funds have consistently underperformed the benchmark index in the long run. While most fund managers charge hefty fee for their services,they fail to deliver. Clearly, actively managed funds do not ensure higher returns.
Buy Winners Sell losers:
Imagine you are a trader of onions and you are in the market to buy onions. You find that the price of onions is at Rs. 20 per Kg, and you decide to buy 100 kg. ?Few minutes later you find that, the price of onions have fallen sharply and 1 kg of onion is now being sold for Rs. 10 per Kg. What would you do? Obviously, since you are getting same amount and quality of onions at half the price, you would buy more.
Unfortunately, this logic is not applied by investors in the stock market. Why? Because investors confuse quality with price. When we buy perfumes from the market, we always go for expensive ones as they are perceived to be better in quality. Our this habit of relating price with quality is the reason why we buy stocks that are going up. We often believe that if a stock is going up, it means it is good, otherwise why would everyone else buy it? Right? Wrong. The quality of a stock is determined by the performance of the business behind the stock.
Every stock has a business behind it, in the long term, it is the performance of the business that determines the price and performance of the stock. If the business performs well, stocks will eventually follow. Instead of chasing the trend, look for quality in a business, buy it at a reasonable price and let the power of compounding work in your favor.
Trading stocks is a better way of earning:
Unlike investing, which is a long term game, trading is a method where capital is invested for a short period of time (as short as an hour or a day) and and as soon as some profits are realized, stocks are sold for a small but quick profit. The reason why trading is preferred over investing is because your capital remains invested for a short period of time, and it gives you regular profit each time you make a profitable trade.
Despite obvious advantages of trading over investing, why do billionaires like Warren Buffett still prefer investing for long term instead of trading in stocks? There are some fundamental flaws in the entire theory of Get rich trading, which is why most traders fail to make money consistently.
In the short term, market movements are largely influenced perception of market participants towards the stock. Since it is hard to predict peoples perception with accuracy, predicting market movements becomes a difficult task.
Trading stocks also requires you to keep an eye on the market for money making opportunities, which means you have to give a lot of time and effort in order to make money. In other words, you have to keep working to make money instead of making money work for you.Investors on the other hand, buy and hold quality stocks, taking advantage of compounding growth in a company, making money work for them.
Buy low, sell high:
The final and most common lie about investing in stock market is buy low, sell high. In other words, trying to time the market. It is believed that if you successfully time the market, you can easily beat all the other investors in term of return on investment. It may sound very simple, but is one of the toughest arts to master. Even the worlds most successful investors have failed to successfully time the market. The reason behind it is that there is no certain indicator, pattern or trend that can tell you when the market has hit the top or when it has bottomed out. Trying to fish the bottom is a task you are mostly destined to lose.
Instead to trying to time the market, it is better to buy quality stocks at a reasonable price, and hold it for long term. Buy and hold strategy is not only easier to implement, it does not require you to spend hours analyzing the perfect time to enter or exit the stock. This strategy is religiously practiced by some of the most successful investors and fund managers such as Warren Buffett, Peter Lynch and John Templeton.
Investing is not as complicated as it may seem, in fact it is so simple, we simply overlook it in order to find more complex answers. It is this habit of ours that allows cheaters and liars to lure us into false promises. They give us complex strategies and formulas we hardly understand. Thinking they know way more than us, we start trusting them, and give away our hard earned money, only to find that there was no such thing in the first place.
The best way to invest successfully in the market is to keep your strategy simple, give your investment time to grow, and to stay away from greed and fear and stay on course without getting distracted. Follow these principles, learn from your mistakes, and move on. Trust me, you will become a money making machine.
Trevor DCruz says
Thanks. Very sane thinking.
Shivkumar Patil says
Nice analysis of market behaviour