Stock Market Investing Strategies For Personal Finance
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Hi, my name is Matt Bernstein, successful online instructor with over 50,000+ students across 192 countries. But, I'm going to make the proper assumption that you have no idea who I am.
From an investing standpoint, my most successful investments in 2008 were, Google and Apple. In 2012 they were, Facebook, Tesla, and Netflix.
Now, you’re thinking, “that’s great for you, how am I going to succeed?”
At the end of the course you'll learn how to…
- Discover and invest in stocks that outperform the DOW and S&P 500
- Maximize your return on investment
- Understand the history of the stock market so you will not be doomed to repeat other people's mistakes
- Decide whether a financial advisor is right for you
- Think rationally about the stock market and think long term
- Determine your risk appetite investing in stocks
- Calculate textbook stock valuations
Who should take this course? Who should not?
- Students with full-time incomes, who want to supplement with a portfolio income
- Students wanting to invest for retirement and maximize their return on investment
- Students who are saving for their children's college education
- Students must develop patience and discipline to know that success does not happen overnight, you have to put in the work
As a very small token of my appreciation:
When you scroll down the page, you'll see some lectures are available to watch for free.
Who is the target audience?
- Students wanting to invest for retirement and maximize their return on investment
- Students who are saving for their children's college education
- Students who are currently investing for retirement and want to learn more
- This is not a get rich quick scheme. Those don't work
- Students must have a brokerage account before investing!
- Do your due diligence before investing
- Outperform the DOW and S&P 500 and maximize their return on investment
- Understand the history of the stock market so they will not be doomed to repeat other people's mistakes
- Decide whether a financial advisor is right for them
- Think rationally about the stock market and think long term
- Determine their risk appetite investing in stocks
- Make textbook stock valuations
Developing an Investor's Mindset
Ask yourself this question; why are you watching this video innovation series and what are you hoping to get out of it?
The most common reason is because you have a desire to make and grow your money. I must caution that it is rare for someone to make a living just by trading in the stock market; rather the markets are a tool that provides the opportunity for turning the money you have already earned at your day-job into earning even more money.
Fear is another common motivator for watching this video innovation series. Everyone has heard of the stock market and the stories of how it can make or break your bank account. It is normal to fear the potential losses but all the while desire the lucrative gains. I’m here to ease your market anxiety.
Others might have tried their hand at investing but found little to no success. With this course I offer up to you the chance to view the markets from my own perspective and what I have found to be successful.
Hi, my name is Matt Bernstein from Low Cost Hustle and there are three main ideas you’re going to learn throughout the course of watching.
First, an introduction to the market. Whether you’re completely unfamiliar with market terminology or not, there is a lot of material to cover here. If you’re confident in your understanding of the market concepts and terminology, you may skip to the second section on thinking rationally. But keep in mind that you had to learn all the letters of the alphabet before you write full sentences.
Second, I’d like to help you get the proper mindset that is necessary for success in the stock market, and that is overcoming your emotions to think in a rational way. I can’t even begin to tell you how many stories there are of people who let their emotions get the best of them and lost out for it. We’ll go through real-life scenarios that will steer you in the direction of a favorable mindset and also provide some history on the markets.
Third, I’d like to take you through the process of how I research stocks for my own portfolio, as well as how I maintain a portfolio to meet my own personal goals. I will explain how I have earned double-digit returns year in and year out.
With this video course, I intend to impart the knowledge and way of thinking that I have developed over the years. I promise that by the end of this series you will walk away with the tools and know-how necessary to outperform well-known benchmarks like the DOW and S&P 500.
So with that, I invite you to learn everything I know about the market and what it takes to outperform it.
The Stock Market
You’re watching this video series with the intention of learning a lot about the stock market, how to make money from it and so on. Well what is the stock market? The stock market in its current form is an electronic exchange where investors can buy or sell shares of stock in a company; kind of like a giant marketplace where the only thing for sale are shares of stock. When you buy a share in a company you are actually buying a piece of the company. So now that you own a share, you are counting on the company to make lots of money so that your shares of stock increase in value. Similarly, if the company makes no money or even loses money, the value of your share will decrease. And so the stock market consists of a great deal of investors who are looking to buy shares of companies that will perform well into the future, and sell the shares of companies that will perform poorly. If you happen to be good at forecasting the future, you can make a great deal of money in the stock market. In section three I will talk about some of the common strategies that myself and others use to try to predict which stocks will go up and down.
Its important to have a firm understanding of what determines the share price of stock. We’ll get into ways of calculating value in section 3 but for now all you need to know is that the market determines the share price. That is, the price is determined by what investors are WILLING to pay for a particular share. As of this writing a single share of Google (GOOG) is valued at over $1,100 whereas a single share of Microsoft (MSFT) is hovering around $36. I want to be clear that these prices DO NOT say anything about the value of the company itself, rather these prices are merely a function of what the investors in the market are willing to pay. And so the fact that shares of Google (GOOG) are trading over $1,100 means that collectively, investors in the market think that one share of Google (GOOG) is worth over $1,100. Human emotion and psychology play a significant role in the pricing of stocks. This is a very important concept that I’d like you to always remember because people can and do have poor judgment from time to time and end up paying too much or too little for any particular stock. Note: There is a lot of money to be made if you can figure out when a stock is over or underpriced.
In addition to stocks, there are other financial instruments I’d like to mention here. I won’t go into great detail in this series because I personally only trade stocks. But I think its important to be aware of what else is out there. I’m sure you’ve all heard of bonds before and possibly options, derivatives and money market instruments.
Bonds are fundamentally different from stocks in that they are a debt instrument. Whereas stock is equity. In the most general sense, debt, in this case a bond, guarantees the bond owner a claim on the value of that bond. For example, if you own a bond with a face value of $1000, you would expect to be paid back $1000 by the company that issued the bond. On the other hand, owning equity, in this case common stock, does not entitle the owner to anything. In other words, purchasing a share of Google (GOOG) for $1000 does not mean the company owes you $1000. It’s a strange concept to understand but ties hand-in-hand with what I was speaking of earlier. That is, the value of stock lies only in what other people are willing to pay for it. Now you might be wondering why anyone would ever buy stock if they weren’t guaranteed the amount they paid for it. Well the answer lies in the methods that people have developed for valuing the worth of a stock; a topic we will discuss later.
Options and derivatives can be confusing to talk about at first so I won’t dive in here. All you have to know for now is they are complicated ways of trading the stock markets that don’t require an investor to actually purchase stock in the common sense of the word. If you are new to the markets, do not; I repeat do not try to trade options. You can end up losing a lot of money if you don’t know what you are doing.
There are two terms you should be familiar with to understand money markets and those are liquidity and maturity. In finance, the liquidity of something represents how quickly and easily it can be converted into cash, with the basic assumption that cash itself is the most liquid asset of all and that a $1 dollar bill can always be traded for another $1 dollar bill. Whereas a house for example is not very liquid because it can take a great deal of time to sell for cash and the price is usually negotiable; that is a house valued at $500,000 might actually be sold for $480,000.
When we talk about the maturity of something in finance we are referring to the length of time the instrument is outstanding. The U.S. government regularly issues Treasury Bills, commonly referred to as T-Bills with varying maturities ranging from 1 month to 6 months. As a new investor the only two money market instruments you need concern yourself with now are T-Bills and Certificates of Deposit. Certificates of Deposit, or CDs are generally issued by a bank and have varying maturities. The basic premise is you hand over $1000 today, and the bank agrees to give you you’re $1000 back plus interest at the end of maturity.
Lets quickly recap what you’ve just learned:
The stock market is an electronic exchange that allows you to trade shares of a company with other investors. By “buying low and selling high” as they say it is possible to profit off these transactions.
The price a stock is bought or sold for is constantly changing second by second and is determined by how much money an investor is willing to pay to own a share. This is the idea of supply and demand.
There are a number of other tradable financial instruments such as bonds, options, and derivatives, that are good to be aware of but we won’t discuss frequently in this course.
Money market instruments are very liquid, that is they can easily be traded for cash, and have short maturities. The two to be familiar with for now are T-Bills and CD’s.
Historical Market Returns: What to Expect
Hi, Matt Bernstein here to talk about the historical performance of the market. There are numerous sites out there offering free historical price data on the markets, and if you’re willing to pay there are some that offer even more in-depth data. I like to use Yahoo! Finance because it is free, simple to use, and meets most of my needs. There is also the convenient option to download any set of data right onto a spreadsheet for you to do with what you like.
When measuring the performance of the stocks we own it’s useful to have a benchmark to compare with so we know how well we are doing. From 1926 to 2009 the average rate of inflation was about 3%. This means that each and every year, the cost of goods rose by about 3%. And so if you pay $10 for a watermelon today, you can expect an identical watermelon to cost $10.30 a year from now. And in 10 years that same watermelon now costs $13.44. What this really tells us is that the money under our mattress loses value over time. And so to keep our money from degrading in value, it’s a good idea to invest it in things that grow faster than the inflation rate of 3%.
Money markets typically have the lowest earnings potential of the investment classes with a historical return rate of about 3.7%. If you invested your $10 in money market instruments, then in 10 years you could expect to now have $14.38. Enough to buy a $13.44 watermelon and have some change left over. As you can see, we have successfully beaten the rate of inflation but only barely.
Bonds fared a little better over the same time period (1926 – 2009), averaging a return rate of 5.5%. The same $10 investment in bonds will be worth $17.08 in 10 years. We made some money but as you can guess there are better alternatives out there.
If you wish to grow your money faster than this, you must find other investment avenues. The truly great thing about the stock market is that it offers the opportunity for much quicker growth than either bonds or money markets.
Large-Cap stocks, those that represent the largest companies in the world, (i.e. the Coca-Cola’s, Exxon Mobil’s, & Microsoft’s of the world) have a 9.8% return rate over the same time period (1926 – 2009). And after 10 years our $10 dollars is now worth $25.48.
Small-Cap stocks, those that represent comparatively smaller companies, have an even more impressive 11.9% return rate over the same time period. In just 10 years our $10 has more than tripled to $30.78. You can now buy 2 watermelons for $13.44 and still have money left over.
It gets better: the large-cap and small-cap average rates of returns are calculated using every stock that meets those size qualifications over that time period. And so these averages also include the stocks of companies that floundered or even went bankrupt. So think of it this way: if you picked 100 small-cap stocks completely at random – meaning some will do great, some will do okay, and some will go bankrupt, you could expect to receive an average return rate of 11.9%. Which means if you had a knack for picking small-cap stocks that didn’t go bankrupt, you could expect a higher than 12% return rate. So when we talk about beating the market we literally mean achieving a higher rate of return than the market averages on its own.
For comparison, my brokerage account lists my average rate of return at a little over 44% each year since its inception. Over that same time period (a little over 5 years) the S&P 500 has averaged returns of just over 17%. And so you can see that I was able to earn 27% more than the market over this 5-year period. In finance, the returns we generate above and beyond the benchmark are known as Alpha, meaning I was able to generate +27% alpha.
Set a goal for yourself: and that is to strive to beat the average market return of 12% each and every year, because otherwise, you might as well just pick stocks at random.
How Good Are Financial Advisors?
Last video we talked about the average performance of different categories of investments, and we learned that an investor that picks stocks at random could expect average gains of about 12% each year. Which must mean that if we are selective in what stocks we purchase, we could expect greater than 12% returns.
Hi, Matt Bernstein from Low Cost Hustle and this video will give you an idea of how well professional money managers do.
Lets begin by looking at the performance of mutual funds. For those of you unfamiliar with the term, mutual funds allow a large group of investors to pool their money together to buy any number of stocks. Run by one or more money managers, mutual funds provide investors with access to a professionally managed portfolio of stocks. They aren’t free and some of them have very high expenses and fees. Investors invest in mutual funds with the belief that the money manager knows how to generate high returns – it is after all their job. Surprisingly, studies show more often than not that mutual funds fail to beat the performance of the broader market. Although professional money managers often have advanced degrees in Economics and Finance from some of the best business schools, studies consistently show that only 1 in 4 mutual funds outperform the market. This is a shocking result that shows three-quarters of funds performing worse than an individual picking stocks at random.
But the truth is more complicated. Just like you and me, professional money managers want to make as much money as possible, and often that comes at the expense (literally) of their investors. It turns out that high fees and expenses are one of the main reasons for this trend of underperformance. Although many of these fund managers are quite good at stock picking, the fees and expenses they charge can end up eating a large chunk of the gains passed onto the investor. And so a fund that earns a 14% return on its investments but charges 3% in expenses actually ends up underperforming the market average of 12%.
Does this mean we should avoid mutual funds? Well that depends on a number of factors including and not limited to:
how old you are
how much money you have to invest
Do you have enough time to do research on your own?
I would argue that if you aren’t:
elderly or already retired
don’t have more than $10 million dollars
or aren’t too busy during the day to research stocks on your own.
Then the benefits of investing on your own versus in mutual funds outweigh the negatives.
Before we go further I’d like to explain two terms you should be familiar with: and those are “sectors” and “indices”. When we talk about indices the Dow Jones, NASDAQ, and S&P 500 are the most frequently mentioned. And the purpose of these indices is to track the performance of a group of stocks. So for instance, the S&P 500 tracks the performance of the 500 largest companies in the United States. When we say that the S&P 500 is up by 10 points today, we mean that the average increase in stock price of all 500 of those stocks was 10 dollars. Some of those stocks will have risen higher, some lower, and some will have even lost value, but on average the index was up 10 points. The Dow Jones, also known as the Dow 30, the Dow Jones Industrial Average, or simply the Dow, is an index that tracks 30 very large companies in the United States. And the NASDAQ Composite is an index that tracks the performance of about 3000 stocks, most of which are technology companies. There are many more indices but these three are the most commonly mentioned.
Sectors describe a particular sub-group of the economy. Technology, Finance, Energy, and Utilities are examples of different sectors and they all have very different behaviors due to the different markets they represent. It is common, for example, to use the NASDAQ Composite as a gauge for how well the Technology sector is doing, and the Dow and S&P 500 are gauges for the overall economy.
In recent years Exchange Traded Funds known simply as ETF’s have been gaining in popularity. ETF’s are like mutual funds in that they hold any number of stocks. However, unlike mutual funds, a money manager does not choose the stocks an ETF holds. Rather an ETF is typically used to mimic as closely as possible a particular index or sector. For example, if you wanted to match the performance of the S&P 500, then rather buying into all 500 stocks one-by-one, you could by an S&P 500 ETF, the most famous of which is the Spider SPY. Whereas if you wanted to match the performance of financial companies only, you might invest in a financial ETF, the most popular being the Spider XLF. The advantage of ETF’s is that they allow investors to trade entire indices and sectors as if they were single stocks.
ETF’s do have fees and expenses but they are usually lower than those of mutual funds. And it turns out that for the same reasons as with mutual funds, the average ETF fails to beat the market because of said fees and expenses. Does this mean you should avoid ETFs? For the passive investor without time to do research on his or her own, I would argue ETF’s are a better option than mutual funds, due largely to the smaller fees and expenses. But for the active investor looking to beat the market, individual stock selection is the way to go. If someone else is doing the heavy lifting for you, then you can be sure they are taking a cut for themselves.
So I hope this video has given you an idea of the advantages of investing on your own versus entrusting your money to someone else. If you’re willing to take some time to do your own research then it is very possible to achieve a much higher return than what most money managers can offer.
Should You Use Financial Advisors?
Hi, Matt Bernstein from Low Cost Hustle here to talk about the benefits of retirement accounts. In addition to a discussion on 401k’s I will also explain the differences between a traditional and a Roth IRA.
Gone is the day when we can rely on social security and pensions to take care of all our retirement needs. It is now necessary for Americans to fund at least a portion of their retirement on their own. Most employers now offer 401k plans instead of a pension. If your employer has a 401k plan I recommend you sign up immediately if you have not already. Once signed up for a 401k plan, your employer will automatically deduct a percent of your salary to be placed in your 401k funds. Your 401k is just an account that invests your salary deductions into the stock market with the idea being that over time this will add up to a lot of money. And what’s better is most employers will match your contribution up to a certain limit. So if you are contributing say 6% of each paycheck to your 401k, your employer will kick-in an additional 6%. Yes, your employer is literally paying you extra money towards your retirement fund out of their pocket. Many 401k plans do not allow you to pick and choose individual stocks, but instead provide access to mutual funds and ETFs. If this is the case, look for an option that offers “high-growth” or “high-risk”. Some funds will have “technology” or “biotechnology” in the name: as a rule of thumb these tend to be high-growth and high-risk funds. If your employer offers a 401k plan, sign up TODAY and opt for the max-allowed contribution.
In addition to 401k’s there is another type of retirement account known as an IRA. An IRA is just an account you contribute money to with the intention of saving it for later. Unlike many 401k plans, you may invest your IRA contributions into single stocks, bonds, CD’s, and really anything else with the exception of options and derivatives. The most frequently mentioned are the Traditional and ROTH IRA’s.
The traditional IRA is the more common of the two and anyone under the age of 70 and a half may open one and contribute. Currently, if you are younger than 50 years of age, you are allowed to contribute $5,500 to your traditional IRA each year. And those over 50 may contribute $6,500. A traditional IRA is a tax-deferred investment vehicle, meaning - only once you begin withdrawing the money in your retirement are you taxed on it.
Similarly the Roth IRA also allows contributions of $5,500 for those under 50 and $6,500 for those 50 or older. However, you are only allowed to make the full contribution if your yearly income is less than $114,000 – there’s a reason for this and it has to do with giving a tax-break to Americans that aren’t considered “rich”. With a Roth IRA you pay your taxes before you contribute the money after which it grows tax-free. So no matter how large the amount in your Roth IRA grows too, you pay no taxes on it when you begin withdrawing money in retirement. I personally have a Roth IRA and make the maximum contribution each year. I recommend the Roth over the traditional if meet the income requirement. Those that contribute the max-allowed to both their 401k and IRA will find themselves living very comfortably come retirement.
Lets do a quick overview of some possible scenarios to see just how much money you can hope to have:
We will assume that you can earn the historical market rate of return of 11.9% on your investments, that your employer will match 401k contributions up to 6% of your salary, that your salary is $50,000, and that you retire at age 55.
For the first scenario I have given an example of someone that does not participate in their company’s 401k plan and saves $5,500 each year but chooses to not invest it in the market. Perhaps they simply keep it in a savings account or under their mattress. As you can see, an individual that invest their money in the stock market has a much more comfortable retirement than someone who does not. And also the earlier you begin contributions to your retirement account, the better off you will be. Someone famous once said that the power of compounded returns is the most powerful force in the world. And here we can see how big a difference just 5 years can make. The person that started at age 20 earns over $2 million more than the person that begins at age 25.
As an added note, these scenarios don’t take into consideration any raises in salary or a better than 11.9% rate of return. These numbers begin to grow much bigger if you take these things into account.
Please realize that it is never too late to start saving for retirement but the earlier you start the better off you will be.
It is much more advantageous to first max out your IRA and 401k contributions but for those that want to earn even more money in the markets, there is also the option of opening up a brokerage account. A brokerage account allows you almost unlimited freedom in your investment decisions, both in the amount you can invest and what you can choose to invest in.
I hope that you at least take advantage of the IRA option but also the 401k options if your company offers them. It really is an opportunity to turn your money into more money, but only if you make sensible decisions. In the coming videos I will explain to the best of my ability how to take luck out of the equation so that you can reach the goals that you want.
Start Planning for Retirement
Old School Investment Strategies
Signing up for a Brokerage Account
What does it mean to think rationally? A Google search reveals the definition of the word rational as “based on or in accordance with reason or logic”. And so it follows that to think rationally, one must make logical and reasoned deductions. Stated in another way, thinking rationally requires the absence of emotional bias.
Humans are emotional creatures and for a good reason: our emotions have helped our species survive as long as we have. But there are many facets of life in which emotions can lead us down the wrong path. It happens that the stock market is one such place where emotion is best left out of the equation.
You’ve probably heard of the saying “buy low and sell high” when it comes to investing. And at first glance it seems like an obvious piece of advice. But time and time again novice investors do the exact opposite.
Observe the most recent financial disaster:
In July of 2007, the S&P 500 reached an all-time high. In the months leading up to this, the market had been continuously climbing higher and higher. It just so happens that in the months leading up to this all time high, retail investors, that is mom and pop investors like you and me, began piling into the markets in droves. Having missed the last few years of amazing gains, the retail investors finally decided they would get in on the market.
But as fate would have it, in the months following the S&P’s all time high, the market began to crash. The United States faced one of the worst recessions since the 1920’s and the retail investors who had just decided to get in on the market were the worst ones hit. Institutional investors had known that a housing crisis was brewing and that the markets gains were unsustainable. In the months leading up to the S&P’s all time high, institutional investors began pulling funds from the market just as retail investors began investing.
So what happened? Well essentially, institutional investors, whom had been in the market for quite some time already, were selling their investments to collect their gains. That is they had bought low and sold high just as a rational thought process would dictate.
Retail investors on the other hand, had done the exact opposite; they got into the market near the highs, and then sold after it crashed, near the lows. They invested in the market near its highs because they had feelings of hopefulness and exuberance. Investing based on feelings turned out to be a huge mistake. Then once the stocks had continually hit lower lows, they pulled out their money - scared that they might lose everything they had invested. This was again a huge mistake as it was one of the greatest buying opportunities in recent history.
There is quote by Warren Buffett, perhaps the most successful investor of all time, that I want you all to memorize: “Be fearful when others are greedy and greedy when others are fearful.” What Warren is really telling us is to go against the herd mentality.
If you can recognize when stocks are significantly overvalued, it’s a sign that others are greedy. Have your exit plan ready.
If you can recognize when stocks are significantly undervalued, it’s a sign that others are fearful. You should begin buying hand over fist.
In late 2008 into early 2009, stocks had become incredibly discounted. There has perhaps never been a better time to find bargains in recent memory. The key was simply to recognize what the bargains were. In 2008 and 2009, there were bargains in all sectors, but the financials were particularly low-priced.
There were fear mongers shouting that the banks were going bankrupt and that the end of economic prosperity was over as we know it. This simply wasn’t true. At the time, the United States government could not afford to let the banks go under, and they showed that they would stand behind the banks no matter what. They literally gave hundreds of billions of dollars in bailouts. To me, this was an obvious signal to buy bank stocks. And so I began to research them heavily in an attempt to find the ones that were most undervalued. I purchased Bank of America stock and never once regretted it.
Always keep in mind that a market crash is an opportunity for you to buy stocks at prices you won’t see for years, perhaps even decades. Be sure you are positioned to capitalize on the opportunity when it knocks on your door.
Investors have searched for patterns in the market for as long as they’ve existed. And a few years ago I stumbled across a chart that found a negative correlation between the performance of markets and the sentiment of news headlines. It showed that as the headlines became more positive, the chance of a market crash in following months significantly increased, and that as the headlines became more negative, the chances of the market doing well in following months significantly increased. For example: it was more likely to see headlines of magazines and newspapers encouraging people to spend money on luxuries or to invest in the markets when they were near their peak. Conversely, headlines were more likely to warn of the dangers of investing after a market crash. Historically, headlines have told us to buy when we should be selling, and sell when we should be buying.
This turned out to be the most consistent indicator of any I have seen. And what it really provided me with was an insight into market behavior and psychology. It was like seeing the famous words of Warren Buffett “Be fearful when others are greedy and greedy when others are fearful” expressed in a graphical representation of data.
What’s more important is it provides a means with which to predict future market behavior. So remember: when everyone is yelling “buy, buy, buy” – it’s likely a sign of irrational excitement. And when everyone is yelling “sell, sell, sell” – it’s likely a sign of irrational fear.
Think Rationally About Investing
Housing Bubble and the Crisis that Followed
I’d like to give a brief overview of the housing crisis that led to the recent market crash and one of the worst recessions the country has seen. The housing bubble, and the crash that followed, is perhaps one of the greatest examples of irrational behavior in the world of finance, at least in recent memory. And for those of you that are interested there is a great book by Michael Lewis titled The Big Short that tracks the story of investors who sensed the crash was coming and made a lot of money with this information.
So first we’ll look at how the housing bubble formed. Here is a chart (not mine:http://4.bp.blogspot.com/-NlOkaaw5xS8/ULTxsOcBRgI/AAAAAAAAWgA/Wu-R7NQO7GY/s1600/RealHousePricesSept2012.jpg ) of historical housing prices going back to 1976. It is immediately apparent that prices rose significantly in the early 2000’s, only to see a marked decline beginning in 2006. This graph alone is enough to make one wonder what could cause such a rapid increase in the price of homes? The answer it turns out is human irrationality.
I won’t get into an argument of who's at fault for the bubble, and consequently its burst, instead I will just tell the story and allow you to draw your own conclusions of where the blame lies.
Throughout the 90’s and early 2000’s mortgage application credit standards became increasingly lax, and people with less than ideal credit scores were allowed to purchase increasingly expensive homes. As a result, the rate at which people began buying homes also increased, and so to keep up with the demand more and more homes were built. The increased purchasing and demand for homes naturally caused an increase in the price of homes and all of these factors began to reinforce one another.
In the early 2000s what are known as adjustable rate mortgages became increasingly popular. Adjustable rate mortgages were designed such that for the first few years after a purchase, the homebuyer would pay a very low introductory interest rate that would promptly rise to a more normal rate after the introductory time period was up. With such low mortgage payments, many people felt wealthy - and began spending and buying...a lot
Things got to such a point that some people were buying second or third or even fourth homes counting on the fact that in a few years the value of the house would rise and they could sell to someone else. And for some people this worked splendidly. But then those attractively low introductory interest rates began to expire, and suddenly people could no longer afford their mortgage payments. Just like that the demand for houses dried up; there were more people looking to sell than buy. Housing prices were now rapidly falling as less and less people had the money to buy a third or second or even first home.
This would go on to be called the housing bubble and its burst sent ripples throughout the rest of the economy. After all if people couldn’t afford their mortgage payments how could they afford to buy anything else? To make matters worse, there was a great deal of money invested in housing mortgages. When homeowners could no longer pay their mortgage, the investments in mortgages went bad and many funds lost a great deal of money, leading to a market crash.
I bring up the story of the housing crisis because it is a perfect example of how bubbles form in the stock market. Almost the same exact thinking applies in a stock market bubble: that is, as people feel wealthier and more confident, they are willing to spend more of their money. And this lax attitude allows prices to rise very high very quickly. Eventually these bubbles burst and those who bought at the peak or waited to long to sell are the most affected.
Don’t allow yourself to be caught in a bubble. Force yourself to take a step back from time to time and think about what you are buying and why. As silly as it sounds you might actually have been motivated by peer pressure when you made a decision and not even realize it. And in the financial world it is extremely important to make logical, thought out decisions rather than simply following the herd mentality. All it takes is one small shock to scare the herd into running the other way.
Risk Appetite and How it Affects Your Decisions
I personally tend to invest in stocks that are considered risky. But your personal appetite for risk might be different from mine. So I’d like to take a moment to help you figure out your risk appetite.
You are comfortable with the possibility of day-to-day price swings of 5%+
You can stomach buying a pharmaceutical stock before the FDA has approved the company’s leading drug candidate, knowing that if the FDA does not approve the drug, the company could be worthless
You are willing to buy stocks with little to no dividend or earnings.
You will only buy companies with historically stable day-to-day prices (i.e. avoid large swings in favor of steady movements)
You will only buy companies that are currently selling a product to consumers
You prefer stocks that have dividends and/or positive earnings.
You prefer to keep your money out of the stock market in favor of fixed-income instruments
These categories are not all encompassing and some of you will be in between somewhere, they are just to help you get an idea of how much money you can stand to lose. It’s also important to realize that there is always some level of risk when you invest, even if you choose what are considered to be safe investments. Before the housing crisis, investments in housing mortgages were considered to be among the safest you could choose from.
I am guessing most of you watching this video identify with one of the first two categories, but if you identified as being risk-averse, that’s okay too. I hope that by the end of this course you have the confidence you need to start investing.
As I said I tend to gravitate towards the higher-risk stocks simply because they offer the greatest return potential. But I have been known to buy into safer dividend paying stocks if I find one that appears to be undervalued. And that’s really what successful investing is all about: finding great deals that other people didn’t see.
But why is it so important to know your risk appetite? Well it can prevent you from making rash decisions in the heat of the moment. Someone with a high-risk appetite can likely handle seeing their shares drop 20% better than someone with a risk-averse appetite. The person with the risk-averse appetite is more likely to sell their shares to cut their losses as soon as possible, whereas the person with the high-risk appetite is more likely to give the stock a chance to recover its losses. And so it is extremely important that you are able to accurately identify how tolerant to risk you are because selling a stock just because the price has dropped is a bad decision. What you should really be doing is figuring out what caused the price drop. And this is an area where being able to read into the validity of market-talk can be very helpful.
For instance, it is not uncommon for someone to write a baseless article about a company with the sole intention of affecting the price. All it takes is for one headline to say “Apple is a bad investment!” and there investors out there who will sell after just reading the title. Does this make any sense? Of course not! We haven’t even found out why the article claims Apple is a bad investment let alone if the article’s argument is credible. Maybe the writer simply wanted to convince people to sell the stock so he could buy it at a better price. This sort of manipulation, though technically illegal, is a factor in today’s markets. But the smart decision is to hold onto your shares of Apple, because you’ve read the article and realized everything the writer claims is nonsense.
On the other hand, maybe there is a perfectly valid reason for the stock price to have moved. Maybe Apple has announced its newest iPhone is a complete flop! In which case you should not sell, but should begin to consider the possibility of selling. And I specifically say, “consider selling” because you should never make a buy or sell decision based solely on a single piece of news. Maybe the reason Apple expects its iPhone sales to perform poorly is because customers are instead buying far more iPads than expected! It is important to dig into any and all news pieces, and determine not only their legitimacy, but also whether or not they mean something bad or good for your shares. It’s quite possible that the iPad selling more than expected will cancel out the iPhone’s underperformance! And there are many cases where a particular announcement at first looks like great news for a company, but actually turns out to have a negative effect on shares, and vice versa.
When you are reading market news and doing your stock research, you should never just take something at face value. There is always another viewpoint to consider, and you have to force yourself to think of every viewpoint you possibly can. If you find yourself reading a lot of articles that suggest a particular stock is a buy – take it upon yourself to find and read articles that argue that stock is in fact a sell. You must be open to any and all commentary and simultaneously decide what is a credible argument and what is not. Only then can you say you have made an informed decision.
Not only will this way of thinking help you uncover good investments, it can also turn a risk-averse individual into someone who is comfortable taking on more risky investments. The more you know, the more money you will make.
Tempering your Expectations
I feel that it is really important to make a video about tempering your expectations because many new investors jump right in hoping to get rich quick. This is not and never has been the case. Money earned from investing is not made in an instant but rather over time, and I want to stress this point because there are many investors who succumb to their lack of patience.
In previous videos I spoke about the yearly average return of the markets being roughly 12%, and I showed you how much money your investments can add up to over the years. The key thing to remember here is that you are investing for the long haul. And even a single year can seem like a long time. And it takes tens of years in a row for your money to grow into a large amount.
Lets go back to the scenarios we looked at for people that started investing at different ages:
It is clear that the earlier you begin investing, the better off you will do. And for some people, this notion of slowly growing your money over time just doesn’t quite sit right. And so I’d like to make it very clear that successful investors have incredible patience. They realize that an investment today doesn’t make them rich tomorrow, or even a year from now. Investing makes you rich 10, 20, or 30 years from now.
If you go place $5,500 into your IRA today, you absolutely must be comfortable with the fact, that that number might only be $5,501 tomorrow. Or it might even drop down to $5,499, or any other amount. But you must realize that the a single day means nothing in the grand scheme of things, because it is only over time you can expect your money to grow into large amounts. In order to earn a 12% return in a year, your money must only grow at an average of 0.03% per day. My point is, do not watch the price of your stocks on a daily basis and think to yourself “ this is taking too long! I don’t have the patience for this!”
Another thing I’d like to bring up is the daily fluctuations in price of both individual stocks and the markets as a whole. The market is a turbulent place, and sometimes the Dow Jones is up 150 points one day, and down 200 points the next. Learn to trust in the decisions you have made in what companies to invest irrespective of market behavior. Price fluctuations should not affect your decision making, because remember: you are in this for the long haul. The only thing that should affect your decision-making is your research and any new news concerning your stocks.
I have a goal that I plan on reaching many years from now. And one of the ways I plan to achieve that goal is through investing in the stock market. I have had to learn about the markets and investing. I have had to research companies to invest in. And most of all, I’ve had to sit and watch my stocks grow once I’ve made a final decision. And this can be the most difficult part for new investors. You’ve made your decision to invest in companies A, B, and C, now what?
Well now you must continually track anything that could affect your stocks. But you most certainly will not buy or sell based on daily price fluctuations. Because you know that through your hours of research, Stock A is selling for half of what it should be, and you are confident that the market will one day value it appropriately. And when that day comes, you will be rewarded for your patience.
As they say, Rome wasn’t built in a day. The same logic applies to your 401k, IRA, or brokerage account.
Tempering Investment Expectations
Maximize Return on Investment
Understand Price to Earnings Ratio of a Stock
Calculate Textbook Stock Valuations
What is the Worth of a Stock?
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