During the past year, a few of my friends have asked me about investing in the stock market. After the recent stock market decline, the calls have intensified.
My view of the stock market has evolved over time
Our perception of the stock market is faulty. The media have created an illusion that people can pick stocks that go up 100% every year. Most of us believe it because we don’t know any better, and then we discover the sad reality, that the stock market has big losers as well, that the stock market is a long-term strategy rather than a short-term game.
To improve the chance of winning in the stock market we should
- Invest in broad-based ETFs
- Have a diversified portfolio of 1/3 Canadian stocks, 1/3 US, and 1/3 International
- Don’t watch the news
- Don’t do any trading
Their responses have been:
- What about Bitcoin?
- What about the latest marijuana stocks?
- What about Tesla?
- What about options?
Generally, they have told me that they want to make some real money. They don’t want to make any of that 8% stuff. They want to make the real stuff, 40% and up.
A person called me to express her disappointment that the Index ETF was only up 10% while her Alibaba stock was up 40%.
Another friend was encouraging me not to ignore the opportunity to buy Bitcoin at $19,000.
Bitcoin is going to $60,000; then I will get out.
He told me full of confidence. Today Bitcoin is about $8,000.
Another friend told me:
Dude I invest in options, that’s where the money is.
The truth is that for almost 10 years all those gambles have paid out handsomely. The US stock market has gone up, uninterrupted. It’s easy to be overconfident, even a bit cocky when you don’t remember when was the last time there was a down month.
But another truth is that the market doesn’t go up forever. The market goes up and the market goes down. That’s how it works. In the long run, you can expect to have a positive return, but in the short run (short run is defined as anything less than 5 years) you can expect a lot of volatility.
Stock Markets also go down
Since the start of 2018
- The Toronto Stock Exchange is down 7.80%
- The S&P 500 is down 2.02%
- and Bitcoin is down 65%
If we look at Chipotle stock price , we will see a drop of 66% from Oct 2015 to May 2018. These market dips are normal. They are healthy. They should be part of the game-plan of every investor.
To recall a bit of history, the Dow Jones has undergone 9 drops larger than 40%. During the time period of 1930-1932, the Dow dropped over 85%.
What a regular investor can do when the market goes down.
- Don’t panic. Realize that it’s normal. The stock market goes up and it goes down. It’s part of the game.
- Don’t own individual stocks, not even for fun, not even with your play money. There is a high degree of probability that your stock will go down to zero, while there is almost zero probability that the Dow Jones or the Toronto Stock Exchange will go down to zero.
- Don’t own assets which don’t produce a return. This includes gold, Bitcoin (Blog post from Mr. Money Moustache about Bitcoin), collectibles, etc. These are not investments; these are speculations. You are buying it with the hope that someone else will buy it at a higher price. To give you an example, I could buy a real estate property and collect rent for the rest of my life. I don’t have to sell it to make money. If I buy a bar of gold or a Bitcoin, the only way I can make money is if there is another person willing to pay a higher price.
- Don’t own Mutual funds, Index Funds, or ETFs that have an expense ratio of over 0.5%.
- Don’t play around with options, commodities, futures, etc.
- Don’t invest in the stock market if you cannot withstand a decline of 50%.
- Have a diversified portfolio. For Canadians, I suggest 1/3 Canadian, 1/3 US, and 1/3 International.
One last piece of advice
Don’t invest in the stock market unless you can stay invested for more than 5 years.
Here is a graph of the Dow Jones Industrial Average for the past 10 years. As you can see, it has gone up more than 175%. That’s 17% per year. All a person has to do is nothing. Just let it sit there and enjoy the ride.
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