What Are New Investors Getting Wrong About the Stock Market? | 7investing
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What Are New Investors Getting Wrong About the Stock Market?

May 4, 2021

Americans have become enamored with investing in the stock market. The problem is that returns over the past year have not been normal. The market has been so hot that returns exceed historical norms and that creates a perception that stocks only go up. That can lead to investors having unrealistic expectations and not really knowing how the market actually works. Having unrealistic expectations can lead to panic selling and other moves that stop individual investors from making money.

On the May 3 edition of “7investing Now,” Steve Symington joined Dan Kline to look at common mistakes new (and even less new) regularly make. This episode also explains why buy-and-hold investing offers individual investors an advantage and why trading inevitably leads to losing money.

A full transcript follows the video.

 

Dan Kline: But Steve, a lot of people have entered the stock market. And that’s great. But there’s also a lot of risk involved. And here’s the problem. The success of the market recently call it the bull market call it the boom, whatever you want to call it. It’s created this artificial thing that stocks always go up. Even when we see like a good stock didn’t like 2%. I’ll let you jump in Steve, give a little rant here. And then we’ll get to our questions and comments.

Steve Symington: And that’s that’s the challenge is that people have learned, especially in recent months, and especially in a lot of your high growth. sort of very volatile, a lot of really richly priced tech stocks, for example, have gotten hit hard. In recent months and a lot of them are down 40, 50, 60, 70%, even from their highs. So people have learned the hard way, stocks don’t always go up. So we have a lot of people chasing returns.

So they say, Oh, yeah, this stock is climbing and it’ll only continue to climb. And sometimes that happens with great names. You add, you kind of average up. But there there are other times when the premiums just aren’t warranted. But it remains to be seen you know how long this sort of correction will endure. But yeah, stocks don’t only go up and and that’s a hard lesson to learn and losing money hurts a lot more than making it feels good. So that’s the challenge.

Dan Kline: This is why we take a long-term investing mindset. When we say long-term, what do we mean? We use the term hold for a minimum of three to five years. The reality is we hold as long as our thesis holds up until we get to a life moment where it’s time to sell. So Steve talks about this a lot selling some Tesla to pay for the downpayment in his house and it feels like it’s bad because Tesla’s gone up since then, but Steve bought a house like that’s important. That’s one of the reasons you invest.

I’m a big fan of and I’ll apply this to my real estate sale. The second I close on both properties, I will stop looking at prices on those properties until which point I’m thinking about selling the one I own. So sure if I if I decide, hey, we’re gonna upgrade or maybe we want to buy another one, then I’ll look but where I’m selling here in West Palm Beach, I’m going to try to avoid ever seeing it again, because I don’t want to feel great that it dipped or bad that that it went up. But let’s share some facts here American households have increased up to putting 41% of their total financial assets into stocks. That’s kind of a bonkers number, isn’t it? Because that’s like, the rest is cash more or less? Right?

Steve Symington: Yeah, it is. I mean, actually, I don’t think it’s, it’s too bonkers. But I do worry about the people’s understanding of the risk of doing so like, I would say more of my net worth is in stock holdings, you know, so we’re kind of driving that number up. But we also do this for a living. So it’s one of those things where you kind of worried that people may or may not really understand the risks of what they’ve purchased. And, and they’re buying stocks, kind of hoping they’ll go up, but they don’t fully understand the thesis, or the risks. And we’ll touch on some of that shortly. But yeah, it’s it’s kind of kind of tough to digest.

Dan Kline: Yeah. So this is an unprecedented market. And as of March 95.9% of the 3000 stocks in the Wilshire 5000. I don’t know why there are 3000 stocks in the Wilshire 5000. But, but there are 95.9, almost 96% are up. That is not typical. In general, in the market, you are going to get your best returns from your best stocks, and most other stocks are going to languish. You’re having a lot of sort of artificial rise. That’s why at 7Investing, we kind of recommend using our stock picks, because we’re not just picking things that some guy in the street thinks are going to go up or Oh, I know, airlines going to be recovery play. They’ll they’ll go up and they probably will. But when things go up for the wrong reason, that’s not sustainable.

You want to look at a company with a business fundamentals, the visit fundamentals that’s a new a new food product, the business fundamentals are solid, a little change in programming. Note that interview with Anirban Mahanti. We’re gonna release it on our social media channels. Later this afternoon, we had a bit of a password snafu, we’ll probably tack that on after the Wednesday show and play it on our social media and our YouTube later today. Hard to hard to get the password while we are on air. But Steve, let’s go through our mistakes. And then we will take all sorts of questions. If you have them. We might cover everything, so you may not have them. Mistake number one, worrying about small moves by good companies. We get asked this every day Apple move 3% should I sell? Steve, what’s our advice there?

Steve Symington: Stay put, I mean, so often, the best course of action is to do nothing. You know, I’ve gotten reports from our people looking at our recommendations. They said, Oh, I bought it two weeks ago. It’s up 10% should I sell now? No we’re buying these again with multi-year timeframes. I’ve also gotten emails, Oh, my gosh, I bought this literally. And they’ve said it’s fallen 1.5% What should I do? Nothing. This is how stocks work. This isn’t a savings bond. This isn’t your money market account. This isn’t something that you get point 1% deposits in your account.

You know, every year it’s stocks are volatile, and volatility is par for the course, don’t worry about little moves. And I would say I’d actually extend that to say Don’t worry about even larger moves. Sometimes you get post-earnings pops or drops or, you know, the stock will be up or down 5, 6,7, 8, 9% in a single day on no news. And this happens sometimes. In those cases, you know, keep an eye on it kind of a side-eye on it and look and just make sure that that thesis hasn’t changed. If it hasn’t touched continue to hold, let it play out for years. And that’s when gains become much more predictable.

Dan Kline: And it’s okay to look at the news. So as people who are professionals, we are making stock picks. I often have CNN, CNBC, whatever it is Bloomberg up in the background, and I will look so let’s say something goes down 20%. Microsoft is my biggest holding, let’s say Microsoft drops by 20%. I will look to make sure nothing happened to the CEO. Or let’s give another example. I get a Starbucks I have a pretty big position in Starbucks fell. I would be I would look and go Okay, was there a food poisoning scandal? Well, that passes quickly. Was there one of those incidents where like something social, social justice, happened to near one of the restaurants and one side likes it the other doesn’t those things pass? Or if Starbucks announced that the price of coffee has gone up by 50% Well, that might impact their business and change my thesis.

So it doesn’t happen often. But it can happen but even then. So let’s say a company changes its CEO. Amazon is, is famously in the midst of changing its CEO, I will argue that Amazon changed its CEO years ago and they’re really just shifting up the titles now. But let’s say you really thought that Jeff Bezos not having the title of CEO would be really disastrous for Amazon, even then I would say let it play out six months, because I didn’t particularly like when Kevin Johnson became CEO of Starbucks, he’s a, he’s an operator, he’s not a coffee guy. Like he’s, he’s very much a tech guy. And he turned out to absolutely be the perfect boss, you know, for what they needed now, who knew that they would need to operate perfectly in a pandemic, but those things still would have benefited the company. He followed a different blueprint than my original thesis, but his blueprint played out, so we’re not going to tell you to sell very often.

But, Steve, I’m going to skip around on our list a little bit here. We are also not going to tell you to buy bad companies. So here’s the mistake people make. They don’t buy good companies, they buy tickers, they buy things that they can tell a short term thesis is going – GameStop is a great example of this. If you could have said before all the hype GameStop would double because you believe they can pivot their business. That’s a plausible thesis, you’re gonna say GameStop can 85x, there was no argument you could make for that. So people buying into that craze are basically buying into a guess they’re buying into, you know, to it to a spin on the roulette wheel. But, Steve, I’ll let you take over here.

Steve Symington: Yeah, actually, there’s a comment from @bonojzk. The second comment, he says, if a stock down 20% if a stock is down, 20% should I double down and let it recover by itself? I’d say that depends. Again, as we mentioned earlier, I mean, we don’t – there are no hard and fast rules. And you know, we don’t I don’t use limit orders, you know, where or limit sells or trailing stop losses or anything crazy thing like that to to limit myself, but I also don’t say, Oh, my gosh, the stock is down 20%. I’m gonna double down now.

You can’t say you just you can’t use hard rules like that. I would say again, it depends. Look at what caused it to drop 20%. Is there any news? Did you like the stock of the previous valuation? Is the thesis broken? Or does it remain intact, but I would say just be patient most of the time. And that also plays to how I actually tend to buy stocks in the first place. When I buy something, I usually buy it in thirds or quarters. So if it falls, I have a little extra cash to take advantage of continued decline if it rises, at least I’m partially participating. But yeah, it depends. I’ll say.

Dan Kline: Steve, I’ll go back to our very own recommendations. This is the third of the month, our new pics came out on the first of the month, which is Saturday. But oftentimes, when I look at our picks, I might know I’m going to buy more of my pick, I’m going to buy some of Maxx’s and maybe I’m going to buy yours or Matt’s or Simon’s or whoever, it doesn’t matter, maybe it’s Dana’s, it doesn’t matter, I’m going to buy some. Now if I know I’m going to buy some, but I was planning on buying it next week when the money transfers into my account. If I see the stock drop 20% I will absolutely transfer that money sooner and buy it. It’s like if you walk into a mall, and you know in a few weeks, you need a new suit and you see cents or 50% off.

So there are no hard and fast rules. But certainly you can use price fluctuation as a way to benefit you. You know if you know if we get a free delivery coupon from Grubhub, we might order food instead of pick it up on a on a weeknight, you know, so definitely factor in basic economics. But you mentioned something that I think is an absolute danger. And we’re absolutely happy to take your questions and comments, see a few others in the queue. Anything on investing, we’ll talk about some specific stocks if you want.

But that being said, Stop Loss orders. Stop Loss orders to me are a nightmare. So you own a good company. That company has some mild bad news that – You own Chipotle. And they have another three people get e coli, and the stock drops by 30%. And you get sold out of it. But then that afternoon, you read a report that says Oh, it actually wasn’t ecoli. Those people had been on a roller coaster beforehand, and they just threw up because they didn’t feel well or, or they had COVID and they didn’t have it from the restaurant. They they had it or the market recognizes that three people getting e coli in a restaurant that uses fresh food is not that big a deal. And all of a sudden the next morning, it’s recovered 28% of that 30% you sold out. You can’t necessarily buy back in at the price you paid. So if you believe in a company, you don’t want to put automatic triggers that get you out of that company.

But Steve, something terrifying is happening in the market. So why don’t you explain a little bit after I throw out this mistake what margin is and why it’s essentially a terrible idea. So we are at a record right now for people using margin to buy stocks that is borrowing money to buy stocks. I will also assume we are at a record for people doing Things like home equity lines of credit to buy stocks, we do not ever recommend this, this is a massive mistake. Steve why don’t you explain what it is and why

Steve Symington: Yes. So when you are buying a margin, it’s essentially, your broker will lend you money you don’t have in order to buy stocks. So you’re basically leveraging against the money that you do have. And I think the statistic was something like, retail investors had $814 billion in margin that they’re trading on. So you actually pay them interest. It’s essentially a loan to buy these stocks. But the other problem that you run into is if your portfolio declines by a certain amount, you can have what’s called a margin call, and they’ll say, hey, by the way, we want you to repay that money right now.

And you’re going to have to sell other stocks to cover that loan and repay everything. But it’s a huge risk, because stocks are hugely volatile, and to borrow money to buy things that you don’t have on and I guess you could extend that also to people taking out loans against their home, or things like that, that. It’s massively risky. And you can find yourself in a lot of trouble really quickly paying, trying to pay back money that you don’t have.

Dan Kline: Yeah, and the problem is, people fall in the trap of if the average return on the stock market is 9% on an annual basis, and I could borrow money at 4%, or three and a half percent, or whatever it is on your home, that seems like well, I’ll just make 6%. But here’s the problem. That’s like saying, if I count cards, I’m gonna win 51% of the time playing blackjack, the problem is, I don’t know which 51%. So you could have a bad luck of market, you can have years where the overall Return of the market is bad. You can have years where you return your picks aren’t great. And over a 30 year career, that won’t matter.

But over those two years, the reason I am so vehemently against taking you know, loans against your house to do anything, but certainly to buy something risky. It’s one thing if you take a home equity loan to redo your kitchen and increases the value of your house, but you live in your home. If things go wrong, and you can’t afford to pay back your added home debt, you know what they do, they take your home and then you live in your car. That is a problem. I am a big believer in security.

Part of why we bought the property I was talking about at the top of the program is we will own it outright, you can’t actually live there full time. But if we decided, hey, one year, my wife wants to take six months off, you can live there six months a year, we could live there at almost no cost, it’s a relatively you know, cost us five or $600 a month to live there. So she could not work or if things went terrible and one of us was out of work or whatever it is, right we have that six months security blanket of Okay, we got a place to live, you know where we can, we can figure things out, we can get back on our feet. Don’t take chances with your house.

You don’t put your kids you know, my son’s 17 we’re going to take some money from our complicated property slipping around and put that into a college fund. Now he’s not going to go to college for about three years. So some if he goes at all, and he may just take classes, he may, you know, get a degree over 10 year who knows we’re going to put money into the market.

But most of the money we would need for year one, if he wants to go full time to a state school will not be in the market. And if he does decide to do that, as we get three years out from the date of when we’d start paying that we will at the right time, make those sales and put it into very, very conservative. When I say very conservative, whenever the best bank account rate I could find which is probably going to be like you know, around less than 1%. Because you don’t want to have the market crash or even just go down 20% like Hey, sorry, you can’t go to college this year. Like that can be a problem.

Let me answer one from our own Matt Cochrane. Matt, that does not include the primary residence that is just cash assets. So it’s not your total holdings. It’s the common ones. This is a number we were talking about before we’re about 43% of people’s net worth aside from their house is in the market, that’s instead of being in bank accounts. And instead of being in CDs, or bonds, or whatever else it might be. Some of that is passively invested. Some of that is in mutual funds. Some of that is in ETFs.

What I would be careful with is the emergency fund. I have a one-year emergency fund, a lot of people have a six month emergency fund. You really need to look at your life and go okay, if I lost my job if my spouse and I both lost our jobs, how long could we get by? And if that number isn’t six months, and remember, you might spend less money if you’re out of work. So you can you can adjust some things down like your cost of commute or eating out or whatever it is. If you don’t have that you probably need to get there before you start investing in the stock market. Now you might be okay with three months if you’re younger, or if you do something that’s you know, easily replaceable. If you’re a you know, a programmer and a high demand field, maybe you don’t need six months. But for most people six months is a good number. Steve, why don’t you take whichever comments you would like to

Steve Symington: Sure. There’s a comment from @112terrasse could have mispronounced that the issue seems to be holding on to stocks for years and then that narrative never materialized. And he continues at some point, you need to give up and move your money to a better company or stock. And that’s a good point. But that’s exactly why we buy and hold for years. And it for those of you who are actual 7Investing subscribers who pay for our service, we do have a what to watch, or what we’re watching section, essentially, with metrics that you should be keeping an eye on to see if the thesis is playing out. And if that thesis has material materially changed, or you no longer believe that they’re capable of delivering on that, sure, you could sell it and put your money to work elsewhere.

But there are other cases where the thesis really playing out takes years and years, you know, I offered Nvidia as an example, and that was the stock that I sold, you know, several 100 shares to help pay for our downpayment on our house five years ago. And the funny thing was, I still hang on to some of that position. But if you look at their charts, you know, the the thesis really playing out, you know, it languished for several years before it really took off the way I thought it could. And and then you have sort of that hockey stick chart that happens when everything actually starts to materialize. So patience is paramount when it comes to investing in the stock market. And, yes, you have to stay put.

Dan Kline: There are times where you look at where your money is invested, and you decide there are better opportunities. And I’ll give a good example. When blackberry moved away from making devices and changed into a software company, right? When TiVo largely switched, it became a patent company, they sell some great devices, actually, but they’re not really a device company. So yeah, both of those two companies changed from public facing ventures, to ventures that you don’t really see. And I didn’t hold either one.

But I liked both companies and could have purchased either one at some point, I likely would have pivoted away, because in those scenarios, the public was never going to view those companies as really successful behind the scenes companies, they’re always going to ask when you’re putting out a phone, is there going to be a new phone is there going to be a new TiVo device, and look, there is a new TiVo device, I own it, it’s $49, it works better than a Roku, it actually is partnered with Roku. It has some really cool features, and nobody bought it. It’s not successful. And it’s irrelevant to the success of that company, which has over a billion dollars a year in patent revenue, and it’s just combined with another company.

So in some cases, you do have to look at I’ll call it anti momentum. We’re just like, it doesn’t matter what a company does. It doesn’t matter how great its numbers are, how much of a turnaround story it is. It’s no longer interesting to the media, and it just kind of never going to get attention that can make smaller stocks a lot more volatile. Sandy. David, we’re going to take your question at the end of the show, because it’s company specific. If you have more investing questions, we got a few more minutes here, Steve, I’m going to throw out another mistake. And that is not understanding the risk profile of what you’re buying.

Steve Symington: Yeah. So that’s, that’s maybe one of the biggest mistakes that people run into. And then all of a sudden, they’re caught completely off guard, by a risk that they didn’t even know existed. And that, you know, the stock is down huge. And that’s also a reason why, you know, we include a section in our reports on on the primary risks, that companies are facing key risks. And and this is a big issue, you know, you run into, you know, is this company paying its its executives way too much in stock based compensation, maybe, but sometimes they you know, that may or may not be a bad thing, in some cases.

Is this company, you know, some have had some unforeseen competitive risks that we don’t understand? Does it have a massive amount of debt coming up, that we need to know about that they’ll basically default and go bankrupt? Does it have unfavorable contract terms? Lots of different things we look at. But you know, we also rank, you know, risk from low to very high, and to determine really, what kind of potential reward because that you could incur, because often, you know, higher-risk companies do come with higher potential rewards. You need to really understand all of the risks that face your company is part of building a comprehensive thesis.

Dan Kline: And I will point out that my pick this month, our picks came out May 1, if you’d like to see what our picks are, you of course, have to join 7investing, we will tell you how to do that in a few seconds. But my pick is very risky. It’s not very risky, because it’s not a great company. It is very risky because if something happened, there are a couple of triggers that could force the company to strategically use a bankruptcy. If they did that they’d likely continue to be a company, but shareholders usually get wiped out to zero in that situation.

So we saw all those people trading JC Penney and Hertz during the bankruptcy period, and of course when the bankruptcy period and they get boom wiped out. There are bad ideas that people follow and look a really good company that if you look at our Maxx Chatsko’s picks, lots of picks in the biomed space, and some of those companies, I own all of them every one since I since I joined, I bought made a small bet on each one. Those companies run the risk of not getting an approval, or it works in a well in early testing and then in stage three testing, you find out it causes blindness, or your ears fall off or, or whatever it might be. So, but those companies if they hit Look, if I bought the company that’s gonna figure out how to cure specific types of cancer well, that’s gonna make up for three that fail. So we explain that risk to you.