First, some very necessary disclaimers: Although I have a brokerage account, I am not a stock broker, or a financial analyst, or a CFP (Certified Financial Planner). And, finally, you can be damned sure I'm not being paid to write this post. I'm only a dummy, with just enough knowledge to be dangerous.
Below the fold is some information that your stock broker may have forgotten to tell you.
Once upon a time, the stock market was a place where Mom and Pop could buy a safe blue chip stock like IBM and keep it for a lifetime. Stocks like this were like money in the bank, paying dividends every year. When one went shopping for a stock, the savvy investor would look at the price-to-earnings ratio, study the market served by the company and the company's future chances of remaining competitive in that market. It seems to make sense that one would want that information before buying that company's stock.
Forget that fairy tale.
Although there has been a minor resurgence of late, most companies no longer pay dividends, and those that do are not paying impressive rates. So, you ask, if that's true, why would someone want to own stocks? Some people would tell you, "Because the stock market always goes up. All you have to do is buy the stock, wait for it to go up, and sell it for a profit."
Then you ask, But what if I buy a stock and it doesn't go up, or even, God forbid, goes down? The powers that be found themselves confronted with that very problem, and developed several different solutions to deal with it. An early fix was "short selling" in which an investor could bet that a stock was going to fall in value, and thus make money when it did. A more recent solution, and a vastly more effective one, involves technology.
The power brokers who control our stock markets, recognized the need for speed. The SEC bought super fast servers, computers that can execute trades in milliseconds. To give you a good idea of how important a millisecond is to traders, the SEC built and equipped a huge building across the Hudson River in New Jersey, not too far from Lower Manhattan, and filled it with these huge servers, which they then made available to anyone who wanted to rent them. Here's why: Light and electrical signals travel pretty fast, about 186,000 miles per second. A trader in Chicago, 800 miles from New York, could rent a server in New Jersey from the SEC and save 4.3 milliseconds of transmission time. All these trades are done by computers using algorithms written by traders, algorithms that have nothing to do with price-to-earning ratios, or companies or markets or products. These secret, proprietary algorithms deal only with the change in the price of particular stocks in relation to the movement of the market, so when the algorithm predicts the direction of change, the server executes a buy or sell order within milliseconds. Much like death by a thousand cuts, the computers make millions of dollars very quickly, a penny at a time. Remember that 1000 point drop in the market not too long ago? Notice the almost daily 100-200 point changes in the market for seemingly no reason? These are the computers, just doing what the algorithms tell them to do. And that, of course, is why daily market trades number in the billions today, up from millions just a few years ago.
Which brings us to market timing: Your broker is right to tell you not to try to time the markets, but that doesn't stop him from trying to do it himself. In fact, if you give it any thought, you'll realize that the entire market is highly dependent on timing. Unfortunately, the market is controlled by myriad robotic Chicken Littles, all running around the barnyard screaming, “The sky is falling. The sky is falling.” But, since chickens, and robotic chickens especially, have very short memories, a sunshiny day or two, and everything becomes just fine---at least until the sky starts falling again.
All this brings us to something else that may have slipped your broker's mind: Buy High, Sell Low. The events occurring with China's stock market as I write this are an excellent example of this phenomenon. People see a stock or an entire market going up. They watch and wait to confirm that their impressions are accurate, then put their life savings into stocks, just in time for a market correction. Then, as they see the value of their investment decreasing, they panic and sell in an effort to save at least some of their money.
An important fact: Let's say you buy a share of stock for $100, and the stock's value falls to $90. You've lost $10, right? Wrong. You lose $10 only if you sell your stock for $90. Keep it and the chances are very good that the stock (unless it was a poor choice to begin with) will increase in value and possibly even make money for you.
Day trading: Not a good idea. Sure, we've all heard the stories about folks who claim to do very well, and the horror stories seem to get buried; day trading, for many people, is simply legalized gambling. But when you're betting against the house, in this case all those computer algorithms, the house is holding all the cards.
So far, we've talked about the Bad and the Ugly, but where's the Good?
The Good part is that diversified, patient, investors can beat inflation and grow their money over time in the market. Here are a couple of suggestions, and one warning:
The big investment companies advertise heavily and I would avoid all of them. I made the mistake a decade ago of letting a friend talk me into moving the bulk of my investments to his company, a very large and famous investment firm which is now owned by a very large and famous bank. These companies rake in huge sums of cash investing other people's money and the grunts on the ground (like my friend) are under constant pressure to generate more and more cash flow. Although this firm did nothing illegal (that I could find), they certainly were immoral, engaging in “churning”, which is constantly buying and selling stocks in my account to generate the fees that come with every transaction. Every month I would receive 30+ page spreadsheets regarding activity on my account with the information presented in oblique, obtuse formats with abbreviated code-like labeling to discourage the customer from trying to figure out what he was being told. In this way, it was almost impossible to discover all the charges against the account, over and above the 2% annual fee I was being charged for "wealth management".
Finally, in disgust, and many thousands of dollars poorer, I moved my accounts back to Vanguard, an investor owned company with several hundred fund choices and a simple, straightforward, easy to read monthly statement. There are no charges at all beyond an annual fund charge that averages just .15% (fifteen hundredths of one percent).
Probably the most important fact I've learned regarding investing in the markets is, don't panic when the market goes down. Because it will go down, just as it will eventually go back up, barring Armageddon .