- A serious lack of financial literacy has led some people to misunderstand the stock market as nothing more than a casino with its volatile ups and downs.
- Today, Alexander Green explains why that may seem true in the short term, but there is no better way to grow your wealth in the long term.
In my recent conversation with Bill O’Reilly on his No Spin News, we talked about the surprising fact that fewer Americans are invested in stocks today than before the financial crisis.
There are several reasons, starting with ignorance.
Blame that, in part, on our abysmal public education system. As the National Commission on Excellence in Education reported many years ago, “If an unfriendly foreign power had attempted to impose on America the mediocre educational performance that exists today, we might well have viewed it as an act of war.”
Many Americans graduate not just from high school but from college without a basic understanding of why we even have a stock market.
(Spoiler alert: The market brings together companies that need capital and investors who want to invest it.)
A share of stock is not just a piece of paper or a blip on an electronic screen. It is a fractional interest in a public company.
A shareholder is a business owner with certain rights who shares in the success (or failure) of a commercial enterprise.
Yet some view the stock market as nothing more than a casino.
And you know what? In the very short term, they’re right.
Share price fluctuations from hour to hour and even day to day are almost completely random. (That’s why day traders usually end up going back to their day jobs.)
Over the longer term, however, there is a great sorting process going on, where successful companies see that success reflected in their share prices.
As Warren Buffett’s mentor Benjamin Graham famously said, “In the short run the market is a voting machine, but in the long run it is a weighing machine.”
And what it weighs is profits, better known as net income or corporate earnings.
Go back through history and you will not find a single example of a public company that increased its earnings quarter after quarter and year after year without the share price tagging along.
Conversely, you will not find a single example of a company’s share price appreciating if it kept reporting declining sales and earnings quarter after quarter.
Even in a rip-roaring bull market.
Luck or chance has little to do with the direction of share prices over the long haul.
Investors who correctly analyze the prospects of a business are rewarded with higher share prices and often bigger dividends.
In the short to medium term, however, share prices can experience neck-snapping volatility. And, as O’Reilly correctly pointed out in our conversation, that scares folks.
However, more people ought to be afraid of what will happen if they don’t invest in stocks.
Invest in Treasurys yielding 2% or less, for example, and you are likely to earn essentially nothing after inflation.
Leave your money in the bank earning 0.05%, and you are guaranteed a negative real return.
Real estate is another alternative. But that requires either a very large chunk of money – something Americans living paycheck to paycheck clearly don’t have – or leverage.
As we learned in the housing meltdown a decade ago, a big mortgage is a double-edged sword, magnifying not only your gains but your losses.
Real estate also entails brokerage commissions, property taxes, homeowners insurance, maintenance, repairs, utilities and the hassles of managing tenants.
And gold? Gold is not a productive asset.
If you own an ounce of gold and, over a period of 100 years (or a million) reinvest all the interest it accrues, all the earnings it generates and all the dividends it pays – zero, in other words – you will have at the end of that period exactly what you started with: 1 ounce of gold.
When investors today talk about TINA – “there is no alternative” (to stocks) – they aren’t kidding.
Equities are not just the best place – they are essentially the only place to put your serious money to work for the long haul.
But how can someone do that if he or she is afraid of the market?
I’ll explain how to safely clear that hurdle in my next column.