In my last video, I reminisced about what 25 cents used to buy in my childhood. Thanks to inflation, money left fallow erodes over time until a quarter won’t buy you beans. To stay one step ahead of inflation, just as you put in a day’s work to earn a decent living, you also must put some of your savings to work by investing in the stock market.
This sets the stage for my next “No Dumb Question: “Nancy, how does the stock market work?” By knowing how stock markets at home and abroad have delivered their returns over time, you stand a much better chance of your money reaching its maximum potential.
Today, let’s take a look at how to give your investments that raise they deserve by putting the stock market to work for you.
Have you ever romanticized what it would be like to pursue your dream career? For me, I would love to be an LPGA pro golfer. Yes, I know I’d have to work on my swing a little bit more. Alright. A LOT more. But I have already perfected my fist-in-the-air celebratory cheer for when I take that $5 million dollar purse.
Don’t get me wrong. I love being a financial professional and independent business owner. And who needs another trophy cluttering up the mantle anyway? The point is, the difference between fantasy and reality reminds me of how a lot of people approach financial markets.
Many investors romanticize the markets, putting their hard earned capital in them with the goal of trying to score bigger, fatter returns than the competition– by being better, faster or just plain lucky at picking the winning stocks and avoiding the downturns. This is traditionally called active investing.
The opposite of active investing is “evidence-based” investing. It’s the approach I recommend in real-life markets, based on four fantasy-busting questions.
First, how do you know when a stock is over-, under- or fairly priced (so you know when to sell, buy or hold)? Trying to outguess the collective, group wisdom that sets market pricing is like walking into a gambling casino and thinking you know more than the house does about why the house always wins.
Second, what causes stock prices to go up or down? Here’s a powerful insight. Stock prices don’t change because breaking news is good or bad. They change when the news is better or worse than expected. For example, even if a company releases a bad quarterly report, if it’s not the disaster everyone was bracing for, its stock price may jump up, not down. Bottom line: Good luck forecasting the market’s unpredictable reactions to unexpected news.
Third, how quickly do prices change? The short answer is, almost instantly. By the time you hear ‘new’ news, it’s already ‘old’ news to the markets. Unless you can find out about it sooner and trade on it faster than automated traders that never sleep and respond in fractions of milliseconds, you’re more likely to end up trying to chip your way out of the proverbial sand traps than consistently connect with that beautiful long drive.
Fourth, can an expert help you get past these hurdles? You may think a star analyst or similar “Market Whisperer” can help you beat the odds anyway. Really? If these sorts of experts existed in sufficient force, wouldn’t we see credible evidence of them being market beating gurus? Not only is such data lacking, there’s substantial evidence to the contrary. Across the decades and around the world, an outperforming active manager often fails to survive, let alone persistently beat comparable market returns. This kind of information is what we mean by “evidence based”.
So, instead of trying to beat our highly efficient markets, why not join them? Once you’ve made your investment plans — and implemented them using efficient, low-cost solutions, — avoid continuously second-guessing yourself. Instead, give those holdings time to grow, so they stand the best chance for delivering healthy, inflation-beating returns over time, after costs, and in keeping with your personal goals and tolerance for market risks.
Are you ready for more “No Dumb Questions?” I’m just getting started. Tune in for more. And send me your questions. I post here every 2 weeks. Until then, maybe I’ll see you out on the links!
