The world of stock investment is one such field where everyone has some advice to share. Unfortunately, most of this advice is just some half-baked truth or an age-old myth. And while people are only trying to help, these myths can deal a big blow to your financial health.
So, with this in mind, I am listing some of the most common stock market myths you must ignore to create long-term wealth.
Myth No.1: The stock markets are too volatile to invest
I hear this very often. Most people I know do not want to invest because they find the markets too volatile. They prefer safer instruments, like fixed deposits. And while money invested in fixed deposits is safe, it does not grow much, which in my opinion is a risk far more dangerous than volatility.
Imagine having invested your long-term money in fixed deposits. A few decades from now, when it is time to withdraw, you will notice it has lost all its value. Meaning, you cannot buy the same amount of goods with the same amount of money as you could when you first invested it. All because of the destructive power of inflation. It only highlights the need for an investment instrument that not only preserves the value of your capital but also grows it in line with inflation.
Stock markets are relatively risky, but have a long history of growth and are ideal for beating inflation over the long-term. Their primary risk, volatility, can be mitigated by diversifying and investing for the long-term. Investing for the long-term has an added advantage. It keeps you from worrying about short-term price movements while giving your investments time to realise their full potential and multiplying your capital.
Myth No.2: Fallen Angels will soar high again
Most amateur investors believe that any stock trading at a deep discount to the market or its peers is a good buy. And while this can be a good starting point, basing your entire decision on the bare assumption can be devastating for your portfolio. As buying a fallen angel is like trying to catch a falling knife; you may hurt yourself.
Confusing these fallen angels with stocks that are trading below their intrinsic value and are indeed a good buy can cause more harm than you realise. But it is a common mistake often referred to as a value trap, entangling those who do not educate themselves.
The key to side-step such traps is simple. All you have to do is some background research on the company; educate yourself about its potential growth and only then take calculated risks that match your financial goals. Invest in stocks with great potential which, for some reason, have been unfairly punished by the market. It is by far the most proven strategy to avoid a value trap.
If you were to look at DishTV Ltd. now, it is trading at a deep discount. But as a company, it is facing a tonne of issues in the near-term and over the long-term. Its promoters, the Essel group, have been in the limelight for all the wrong reasons. Furthermore, continuous technological changes threaten the longevity of the business. But the only way to know all this is to do some background research so you can avoid this value trap.
Myth No.3: High risk always equals high returns: to generate higher returns you must take on higher risks
Most investors have grown up on the adage that high investment risks will earn them high returns. And while that is true that some investments are far too risky, like derivatives, not all assets are entirely risky at all times.
Think about it. Mr Moskwitz won a Nobel prize for proving his theory - that with high risk comes high returns. But this theory of high risk comes with the assumption that you already have a highly optimum portfolio referred to as the Efficient Frontier (set of optimum portfolios). And so to generate higher returns, you need to take higher risks. But why take higher risks? An investor can simply start by building an optimum portfolio; a well-diversified portfolio of stocks that do not carry high risks.
Bear in mind that 'risk comes from not knowing what you are doing' - Mr. Buffet. It is this risk that needs attention and is easy to mitigate. So, focus on investing in companies whose business are simple to understand. You have to know all the reasons why a company will thrive. Failing to do so, and you will not recognize any signs that it may fail.
Myth No.4: When it comes to buying a great company, the price does not matter!
Now, this could not possibly be farther away from the truth.
Finding a good company is only winning half the battle. The other half is about getting it at the right price.
No matter how good a company is, buying it at the wrong price will never make you good money.
The stock price of a company is purely a function of the value of its underlying business and ultimately converges to that. So before buying a company, assign a value to its underlying business by studying its true potential. It is the only way to create long-term wealth.
Myth No.5: Long term investing means more than 1year
'You are better off investing for the long term in the stock market.’
‘Over the long term, the stock market is likely to generate a 13-15% return.’
You often come across such statements, not knowing how long ‘long term’ really is. Some believe it to be a year, while others consider it to be more than two years.
From a taxation perspective, investing in stocks and equity mutual funds for up to a year is considered long term. But that is not what the investor gurus are talking about.
You can define long-term investing in 2 simple ways:
Staying invested in the market for five years or more OR
Sticking to a particular fund or even stock over its entire lifetime.
'Our favourite holding period is forever' - Warren Buffet.
Just ask yourself how much of your investment portfolio do you want to commit and for how long? You need to find the right balance for you and your situation. In the end, whether it is short-term or long-term, the key is to have clear goals in mind. So you can match them to your investments.
Myth No.6: Stock markets are a get rich quick scheme
I am afraid some of the brokers and business news channels shoulder the blame for this myth. As thanks to them, people often perceive that stock markets can help you get rich quickly.
If you too believe this, you have misunderstood the basics of stock markets. You have forgotten that behind every stock, there is an underlying business. And no matter how good the business is, it will need time to grow and make money for itself as well as its stakeholders. So assuming that the stock markets are a get rich quick scheme would be wrong.
A few months ago, when the fate of Yes Bank was hanging in the balance, several speculators flocked over to make a quick buck. They were effectively betting on the future of the bank; if it would be merged or find a new investor etc.
Unfortunately, it did not pan out well, and the stock price tanked. But if the bank had managed to find a new owner at a good price, the speculators would have made supernormal returns in no time.
To make money in the stock markets, you must have patience, a virtue all successful investors have. Patience to buy a stock and hold it for the long-term. Patience to allow the business to go through ups and downs and realise its full potential.
If you do not know much about a subject, you will make silly mistakes. So it is important you either seek some help or educate yourself on the subject. It will help you debunk any myths and save you a considerable amount of time, efforts and money which you would have otherwise wasted.