Should You Invest In Stocks?
"You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in markets." – Peter Lynch, American businessman and stock investor, who managed the world's largest and most successful mutual fund for Fidelity Investments between 1977 and 1990.
At Tauro Wealth, we often come across some typical questions, especially from people who are new to the idea of investing – Is stock market investing suitable for me? Aren’t stock markets very risky? Isn’t stock market investing akin to gambling? And so on.
Like Roulette in a Casino
Are stock markets risky? The answer to that question is an emphatic YES. Anyone who tells you otherwise if either fooling you or fooling themselves, which is probably more dangerous! Investing in stocks has its fair share of risk. But what most people don’t realize is that this risk is more than compensated by the returns that stocks markets offer – if done smartly and patiently! But first and foremost, it is important to understand that what most people consider investing in stocks is not really investing – it is punting.
According to Wikipedia, a punter's approach is to speculate rather than invest. Thus, punters aren't concerned with the fundamentals of an investment; instead, they attempt to make a quick profit by selling to somebody else at a higher price. Punters speculate in any market, but especially like options, futures and forex because of the leverage.
Today, you can get stock “investing” advice from at least a thousand different sources. There are financial experts presenting their opinions on TV and Internet 24x7, investment advisors burning a hole in your pockets to give you stock tips, brokerage companies publishing hundreds of research reports, analysts telling you which stocks to buy/sell at what price, etc. And the worst of them are pitching derivatives (futures and options) where you can make 10-times your investment in just a few months!
What’s the one thing that is common amongst all these so-called experts? They are all telling you to punt instead of invest. And what’s more troubling is the fact that they tell you this is stock investing! Buying or selling stocks in order to make quick profits is exactly what investing in not! And comparing derivatives trading to investing is like saying that your day job is play roulette in a casino. It can be an extremely exciting thing to do but you are never going to make any money in the long run! So, to summarize what we have learnt so far, it is extremely important to understand the difference between stock investing and punting. And only after you have understood this difference should you think about whether stock investing is suitable for you.
"The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient." – Warren Buffett, widely considered the world’s best stock investor.
The Risk - Return Trade Off
Before trying to figure out whether the stock market is a suitable place for you, you must learn to recognize what an investment is. There are many things that we do in life which can qualify as investments. Studying hard to get in to a good college is an investment for a secure future. Working day and night on a project at work is also an investment for that next promotion. Similarly, using money to buy an asset that is expected to grow in value over time or provide an income in the future is a financial investment. There are many different kinds of financial investments available. The two key differentiating factors between them is the return they can generate and the risk inherent in them.
In general, any investment that offers a higher return will also have a higher inherent risk. What makes any investment good or bad is whether the higher return compensates for the higher risk in the long run. Let’s take the example of a simple fixed deposit vs. a stock investment. In the former, you can get up to 8% return every year with little to no risk of losing money. In the latter, you can generate a return of 15-16% every year but there is also a chance of losing part of your capital. The question is whether that additional 7-8% returns are worth the risk of losing some part of your money. That’s the only question you need to ask yourself when deciding whether stock market is a viable investment option for you.
In order to honestly answer this question, you must imagine what would happen if the worst possible outcome actually came true. Let’s say you invest 1,00,000 today. Two years later, your investment is worth only 60,000! Would this put you in any kind of financial trouble? Is your financial stability dependent on the performance of your investment over the next few years? If the answer is yes, then you MUST stay away from the stock market. This hypothetical scenario is not only possible, but has actually happened multiple times in the past and will happen multiple times in the future. What makes investing in stocks worthwhile is that over a period of 10-15 years, the average returns are much higher than any other asset class available.
So, for someone who can weather the storm, the final outcome is well worth the bumpy ride over the vast open sea that is the stock market!