Author: Todd Campbell | November 05, 2018
What's the reality?
There are plenty of misconceptions associated with investing in stocks that could be jeopardizing your future financial security, so let’s bust some myths. Read on to learn 14 truths about stock market investing and how stocks can help you achieve financial freedom.
Myth No. 1: Investing in stocks is hard
Not really. There are plenty of simple ways to invest in the stock market. For instance, most employees are offered retirement plans at work that allow them to buy mutual funds that invest in stocks. These funds are run by professionals who pick and choose which stocks to buy, so investing in stocks through a mutual fund is as simple as selecting a fund. Unsure what fund to pick? Many plans offer Target-date funds that take the guesswork out of figuring out how much to invest in stocks or bonds based on the age at which you expect to retire.
Myth No. 2: The stock market is too risky
It’s true that stock prices can fall, but it’s also true that the S&P 500 stock index comprising the biggest companies in America has produced a positive return for investors in every rolling 20-year period since its inception. Yes, the stock market will fall from time to time, but historically, it’s recovered from every one of these setbacks and gone on to reach new highs. If you can ride out the market’s inevitable swoons without selling, then history suggests investing in stocks may not be as risky as you think.
Myth No. 3: Picking individual stocks is like gambling
I suppose you can make investing in individual stocks like gambling by picking stocks by using darts, but savvy investors don’t do that. Instead, they do their homework. They invest in companies they know and love. They learn as much as they can about the company’s business by reviewing annual reports, using their products or services, or talking with people with expertise in the company’s industry. In short, investing based on an understanding of a business is not the same as throwing dice at a wall.
Myth No. 4: Buying stocks is expensive
Buying stocks used to be expensive, but that’s not true anymore thanks to low-cost exchange-traded funds, or ETFs, and discount brokers. Exchange-traded funds are like mutual funds, but they often charge fees that are lower than mutual funds. Similarly, commissions charged by brokers are often low or in some cases, nonexistent, depending on the brokerage. Individual stock commissions could cost $50 or more in the past, but thanks to discount brokers like Charles Schwab (NASDAQ: SCHW), they’re often less than $5 per trade. Some brokerages may offer free commissions to clients with large accounts, too.
Myth No. 5: I can’t buy individual stocks in my retirement account
It depends. While that’s true of many workplace retirement plans, some 401(k) and 403(b) plans allow it. If the retirement plan is an Individual Retirement Account (IRA) at a brokerage firm like Schwab or Fidelity, then you can buy individual stocks. If the IRA is at an investment firm that only offers its clients mutual funds, then to buy individual stocks, you’d need to open a second IRA at another firm that allows it.
Myth No. 6: The fees I pay are the same everywhere
Stiff competition between discount brokers means commissions on individual stock trades are often similar, but full-service brokers can still charge considerably higher commissions, plus fees. Similarly, fees charged by mutual funds and ETFs can vary, even for index funds. For instance, the ratio of expenses to assets that’s charged by Vanguard’s S&P 500 ETF (NYSEMKT: VOO) is 0.04%, but the SPDR S&P 500 ETF’s expense ratio is 0.0945%, or nearly twice as high as Vanguard. The expense ratios for actively managed growth funds or specialty funds can easily exceed 1%. Sometimes it can be worth paying more for market-beating returns or top-notch service, but all things equal, if you aren’t paying attention to fees you could be short-changing yourself.
Myth No. 7: The Securities Exchange Commission protects me from losses due to fraud
It’s true that companies that sell stocks on the major public exchanges are regulated by the Securities Exchange Commission (SEC), but the SEC doesn’t vet every accounting report or corporate report filed with it. If it becomes aware of fraud, it will investigate and act, but any money that’s recovered is likely to be less than investors lost. To lower the risk of becoming a victim of fraud, it can pay to be wary of unsolicited offers that sound too good to be true. You can access a database of licensed brokers and tips that can help you avoid fraud on the SEC’s website.
Myth No. 8: I can make more money buying penny stocks
The price per share of a stock is less relevant to picking profit-friendly stocks than a company’s business strategy and prospects. Penny stocks usually trade on the over-the-counter market, or pink sheets market, and they’re lightly-regulated. Also, because few people buy and sell penny stocks every day, their share price can be easily manipulated by fraudsters. Instead of buying a stock because its share price is measured in dimes, nickels, and pennies, it’s best to invest in companies you know and understand. After all, a 10% return on a $100 stock is the same as a 10% return on a $1 stock.
Myth No. 9: Dividend stocks are 100% safe
It’s been shown that dividend stocks outperform non-dividend paying stocks, but that doesn’t mean that all dividend paying companies are equal. Often, a stock’s dividend yield, or the income you’ll receive per year in dividends divided by the stock’s share price, increases because the stock’s share price has fallen due to problems with the company’s business model or financial position. When that happens, a company may be forced to cut or eliminate its dividend to get itself back on solid financial ground. Like any company, dividend paying stocks can go bankrupt, so investors should understand the company’s financials and the likelihood of its dividend continuing before pressing the buy button.
Myth No. 10: I need a lot of money to buy stocks
In the past, many brokers wouldn’t accept clients unless they had a set amount of money to invest. However, that’s changed as technology has allowed discount brokers to profit from smaller accounts. For example, Schwab waives its $1,000 minimum for a brokerage account when investors commit to automatically add $100 or more per month to their account. Also, new companies, including Acorns, have emerged with unique business models that help you invest in stocks with very little money.
Myth No 11: Stocks that fall will go back up
It’s tempting to buy a company after its share price has fallen sharply, but it’s wrong to think that a stock will see its share price recover to the same levels it was once trading at. The belief a share price will recover lost ground is called anchoring bias and that bias can cause you to stick with a company on its way to bankruptcy. Instead of assessing a company’s value based on its past share price, you should consider its value relative to its business prospects today.
Myth No. 12: Stocks that are expensive will fall
There’s no limit to how high a stock price can climb and there’s no set limit to how “over-valued” a company may get based on traditional valuation metrics, including price to sales or price to earnings ratios. It’s true that high-flying stocks that trade a multiple to sales and earnings far above that of the S&P 500 are expensive relative to the market, but often, they’re expensive for a reason. For instance, Amazon.com has been considered by many to be too expensive to buy because of its valuation for 20 years, yet its share price has climbed to $1,624 from $5.02 since 1997.
Myth No. 13: Investing in stocks is easy money
The stock market has more than tripled since March 2009 and that might have you thinking picking stocks is an easy path to riches. If your investment horizon is decades, you invest in top companies, and your idea of easy money is the market’s historical average return of about 6% per year, then yes, stocks can produce easy money. However, if your time horizon is measured in days, weeks, or months, you expect triple-digit returns out of the gate, and your idea of stock-picking is chasing fads, then you’re likely to be very disappointed.
Myth No. 14: Investing in stocks is intimidating
Finding stocks worth buying requires work, but you don’t need an ivy league degree to do it. Millions of people just like you are successfully scanning their daily routines for investment ideas, researching those ideas, and learning from others who are on a similar journey toward financial freedom. Resources that cut through the jargon to help you learn about industries, companies, stock picking strategies, and the risks and rewards associated with investing abound, so don’t let intimidation stop you from investing in mutual funds, ETFs, or individual stocks.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Todd Campbell owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.