I’ll admit it right away. I love stocks. While I teach economics, finance, and accounting that covers a wide range of different topics, I somehow always find a reason to talk specifically about stock investing. When I get back from work my focus is on my podcast, a podcast that is again about stock investing! When I finally finish everything, I constantly find myself reading…well, you guessed it; yep, it’s about stock investing.
I’m often asked the simple, but powerful question: “Why do you invest in stocks?” Luckily many people don’t find stock investing speculative, but people are rather interested in investing in general and simply want to know which asset class they should focus on. Often, we first talk about the potential expected return which typically doesn’t get most people excited… After all – if you look at the returns from 1900-2000 you would have made between 7-8% in annual return if you bought Dow Jones. So what is all the fuss all about? Fair question! Let me break it down as to why I’m hooked to stocks.
Stocks are liquid
This argument typically surprises people. Is liquidity really that important? As a business owner, I have to say yes. Several years ago, I started a company that was servicing people in personal finance. I loved it! Unfortunately, as it happens in life, I suddenly got very busy with other things and I didn’t have the time to run it, and I had to sell it. Since I was under a time constraint, I quickly became what you would call a “motivated seller”. Being in a hurry is typically not a good sales strategy, and it sure wasn’t a good strategy for me. In other words, the price I got wasn’t really that great. And why would I get a good price? I was the only seller, and buyers were nowhere to be found.
Let’s relate that to the stock market. In the stock market you can sell your stocks anytime and you can get access to your funds in a matter of a few days. You might not always be satisfied with the price you are getting, but knowing that you have hundreds if not thousands of potential buyers every day, typically gives you a much better price than 0 buyers (believe me!). The liquidity of stocks simply gives you multiple options that you can take advantage of, which many other classes don’t. Most investors don’t have millions of dollars to invest with, and they rather have an odd dollar figure in their account where every dollar matters. Let’s say that you have $14,342. In this case, you can come pretty close to investing all your money in your favorite stock(s) as 10,000s of stocks trade below or around the $100 mark. In other asset classes like real estate or land development, investments are often not possible for that kind of money, and even when you can, it might only be possible to employ a part of your capital.
Stocks are (almost) passive income
I often hear my business students sigh when I talk about superior stock returns in the area of 10%+. That is the kind of return that impresses me, but for those students who consider building their own assets a stock return of 10, 15 or ever 25% seems arbitrary. They (luckily) keep pitching ideas of small business ventures to me where the upside of a new app or online business is projected to be in 1,000s of percent.
Having curious and ambitious students is the best thing in the world! I love the eagerness and motivation to build their own business, and surely many students and entrepreneurs get much better returns than what they do in the stock market. But when I have to be a grumpy old man (which is always fun!), I remind them of the concept of “sweat equity” and “risk”.
I think everyone that has started their own business learns pretty fast what “sweat equity” is. It’s all the hours you put into your business. To illustrate this, I often ask my students the mark up they think they can get from setting up a lemonade stand. All they need is lemons, sugar and water. Quickly, they see my point. While they could be making hundreds of percent in a day in return, they also have to factor in all the time they have to spend. That is a very real cost too!
The other thing is “risk”. To me risk is the same as losing the principal on my investment. Most businesses can only resell for a fraction of whatever the start-up bought for the capital they put up if the business doesn’t go as planned. More often, the capital is just completely gone.
Perhaps I’m just lazy, but the element of spending very little time to make money really appeals to me. Yes, stock investing takes time but for the sake of argument, let’s say you simply buy an index tracking S&P500 every month. You can do this yourself in less than 2 minutes, and some services can even arrange that as a portion of your monthly paycheck, where it’s deducted from your account and invested in your favorite index.
I also like the idea of not losing (all) of my money. Can you lose money in stock investing? Sure – I’m as guilty as charged, but by definition, stock investing when set up the right way makes it impossible for you to lose your entire principal. Basically, stocks are real businesses. If you buy the S&P500, you buy into 500 of the very best businesses in America. The likelihood of all of them going bankrupt is as close to 0 as you can get. But, can you have swings of 30% or more? Sure! However, the stock market allows you to wait for the right time to sell your liquid assets. Stay away from debt, single stock picks, and crazy derivatives and a complete loss of capital shouldn’t be possible.
Stock investing is simple (but not easy)
It takes a great deal of courage for me to come up with such a statement. When I started out in stock investing, I would be the last person in the world to say that it’s simple. However, I think I confused “simple” and “easy” for a long time. I would rather argue that stocks are simple because: “Stocks are just real businesses”. If you own stock in a business that makes a profit, then that profit will ultimately return to you as a shareholder. Clearly, there is a lot more to stock investing than this. Many people, including myself, study the field intensely to get something that’s better than market return, but anyone with no stock market talent can also get a very decent return.
Now, I did say that it wasn’t easy right? After all, why are most people not doing it if it’s that simple? I think one of the main reasons is the lack of knowledge. There are a lot of barriers before you actually start building your portfolio. For starters, you need capital, time, and knowledge of the stock market. You also need to create an account at a broker, fill out forms, and … what then? I still remember going down to my bank and asking them to show me how I could place an order online – I simply didn’t know what to click on. The next part was even trickier. I heard that if I liked stocks as an asset class, but didn’t know which individual stocks to pick, I should “buy the market”. Back to square one: How do you place the order for the whole market?
The technical part is only one thing. If you, like me, have your bank or a friend to get you started, it can be too hard to start building your portfolio. For most people, the hard part comes after they buy the stock. I don’t know about you, but I remember checking the stock quote at least 5-10 times the day I bought my first stock. Later when the first earnings report came and I lost 10% in a day, I forced myself to keep calm and think back to when I first bought the stock. I told myself, “You are buying a great business (it wasn’t), and over time you will make a profit (I didn’t).” The thing about stock investing and why it’s not as easy as investors sometimes try to make it seem, is because of how we play mental games with ourselves. I am embarrassed to say that I calculated how many bags of pasta I could have bought for the 10% drop that day. Yep, that was my way of making a very simple game very hard to play.
Should you invest in stocks too?
To answer this, I think it’s important to establish that I don’t think you should be looking at the current prices of stocks. This might seem like the worst investment advice you have ever gotten, but I think the decision is very fundamental for your approach to investing. Not just because very few people can master multiple asset classes, but I think this is looking at investing backwards. It’s like saying, “Few people are playing curling (so sorry, Canadian friends). This is now my favorite sport to play, since it will probably be easier to win.” Obviously you should choose a sport where you have talent and passion; otherwise you will never be successful.
I doubt I’ll ever be good at curling, but I think I will do fine in stock investing. The whole process about stock investing suits me because the benefits such as liquidity and that its passive income are a priority to me. The disadvantages, specifically the mental pressure, I have learned to live with. Before considering whether the stock market is high or low, or how you buy your first stock, I would rather carefully evaluate if I like stocks as an asset class. If the answer is yes, the rest is likely simpler than you think.
P.s. As usual, I want to hear if my analysis is right or wrong! If you’ve got some comments or questions about this post, be sure to contact me directly.