Even for those who know nothing about investing, they've heard of the stock market. Each night on the evening news telecasts, the level of the Dow Jones Industrial Average is reported. When there is a significant market move up or down, it's often a front page story. This allows for the stock market to hold a kind of celebrity status in many people's minds. However, for those looking to put some of their hard earned money to work, is the stock market a place to make money or is it a financial wolf in sheep's clothing?
TUTORIAL: Index Investing
1. The Market Is Rigged
If you're avoiding the stock market because you've heard that it's rigged, that is debatable. When we hear stories of Bernard Madoff and the many other cases of insider trading scandals, it's easy to believe that the market is made up of greedy people willing to break the law to make a few bucks - that they're making the money by taking yours.
Barry Ritholtz is a well-known financial blogger who was interviewed by Yahoo Finance recently on this subject. He said that although insider trading certainly takes place, the bulk of the information that may be considered inside or privileged information is nothing more than rumor that is often untrue. Because of that, professional money managers conduct their own research and ignore the rumors. Ritholtz goes on to say that where the individual investor is at a disadvantage is that they lack the tools or manpower to sift through the huge volume of information publicly available. The market certainly has people who are breaking the law, but the pros are just as vulnerable as the little players. (Many would-be, first-time investors in the stock market do not believe it is a fair playing field. Check out Is The Stock Market Rigged?)
2. Computers Run the Show
This is true. Current statistics show that computers are responsible for 70% of all trading volume in the world markets. Millions of stock trades are taking place each second and those computers aren't evaluating stocks using the typical screening criteria that is publicly available to the average investor. Proprietary computer programs are often not even fully understood by the people using them. While the retail investor might be evaluating the quality of the management at the company, a computer may be evaluating the mathematics of the price history of the stock.
If computers are controlling 70% of the price action of the stock, how is an individual supposed to forecast the direction of a stock? The modern part-time investor may be best served by long term investing that allows for the characteristics of the company to play more heavily in to the equation.
3. It's too Tough for the Average Investor
This may be cause for fear unless you ask former hedge fund manager and CNBC commentator Jim Cramer. As stated in his book, "Real Money," Cramer believes that the retail or part time investor can make money in the stock market by following a set of rules. Among them, conducting at least one hour per week of research for every stock owned. Of his 25 investing rules, others include diversifying your portfolio and buying stocks that are undervalued but not purchasing stocks of damaged companies.
His contention is that many retail investors lose money not because the stock market is too difficult but because part-time investors don't have the time or may not be willing to put in the time needed to make informed decisions in a complicated market.
4. The Economy Is Bad
One of the real reasons to fear the stock market could very well be the economy. The Federal Reserve reports that for every 20% drop in the stock market, gross domestic product is reduced by 1.25% after one year. However, as any seasoned investor knows, the stock market rarely represents in real time the state of the current economy. When the economy is questionable, the stock market tends to be the same way. Investors may see a quick rise in prices presenting a false sense of security only to see it violently drop in value in a short time.
A struggling economy is definitely cause for fear of the stock market, and some would recommend new investors wait until some stability in the market and the overall economy is seen. The problem is that finding stability in the stock market may take a long time.
5. It Has Gone Up Fast
Since the 2009 lows, the stock market has risen more than 70%. For many, that's a recipe for disaster. If anything is a cause for fear, this may be it. On one hand, markets that move up fast tend to fall fast - with a market that has been in bull mode for the past year, that should scare any investor.
Others will argue that the market is up drastically because the Great Recession caused it to drop just as violently, which makes the recent uptrend a move towards fair value. So which of these opposing views does the part time retail investor believe? Do they have enough experience and expertise to make an informed choice? Unfortunately, there is no easy answer. (For additional reading, see The Rise And Fall Of The Shadow Banking System.)
The Bottom Line
When investing, the stock market is definitely cause for concern but sometimes a little bit of fear is healthy. Avoiding putting your money to work because of fear probably isn't the best course of action either. If you don't feel that you have the necessary knowledge, get help. Find an independent, fee based financial advisor in your area to help you make a reasonable return while teaching you about the ins and outs of the market.