Fire Your Stockbroker!
Home | Articles |
* The Best and Worst College Majors<br>* The Levels of Human Experience<br>Book Reviews<br>Boycott Microsoft<br>Everything You Know is Wrong<br>Fire Your Stockbroker!<br>If I Were In Charge<br>Jokes<br>Programming Handheld Calculators<br>Stocks and Stockbrokers<br>Symmetry<br>The Best and Worst College Majors (PDF)<br>The Idea Carnival<br>Was Thanos Right?
Share This Page
Fire Your Stockbroker!
Investment myths disproven
— P. Lutus —
Message Page
Copyright © 2020, P. Lutus
Most recent update:
Overview | Stock Market | Market Index | Efficient-Market Hypothesis | WSJ Dartboard Contest | Trading Is Hazardous to Your Wealth | Investment Performance | Compound Interest | Brokered Account versus Index Fund | Growth Investing | Broker Advocacy | Misrepresentation | Secrets of the Winners | Miracle Man: The Scam | Miracle Man: The Reveal | Conclusion | Reader Feedback | Doubts about the EMH | Notes/References
(double-click any word to see its definition)
Overview
Update : See the video version of this article.
"My favorite time frame for holding a stock is forever." — Warren Buffett1Warren Buffet, successful investor and philanthropist.<br>-->
When people invest in stocks, they often fall prey to a false belief, a belief I intend to demolish in this article. The belief is that paying a stockbroker2Stockbroker — a stock market professional who, for a fee, acts as an investor's agent. In this article the term applies to all investment advisors.<br>--> to manage your money confers an advantage over direct investment in a no-load market index fund3Index Fund — a stock market fund that tracks a market index like the Dow-Jones Industrial Average, the S&P 500 or another index. Index funds often have negligible investor costs because they require no management and there are no sales commissions.
-->. This belief is false, it's been proven false repeatedly, but the entire investment industry does all it can to keep you from discovering it.
Now that banks can legally pay almost no interest on individual accounts, the equities market is one of the few available ways to grow your money. But to do this effectively, consumers need to learn how equities work. Unfortunately, hiring a stockbroker is one of the most common, but possibly the least efficient, ways to invest your money.
In this article I explain how equity investment works, why it differs from most human activities, and how human instincts undermine the process.
Before we begin, I want to say something about American education. If Americans were educated in critical thinking4Critical Thinking — a valuable mental discipline that isn't taught in American public schools.<br>--> and skepticism, in math and science, if we were taught how to think instead of being told what to think, stockbrokers would be out of work.
Let's get started!
Stock Market
The stock market5Stock Market — one method by which businesses raise capital.<br>--> is a way for businesses to raise operating capital. Simply put:
Businesses have ideas and products but no money to develop them.
Investors have money and want to make a profit by investing in ideas and products.
The stock market brings businesses and investors together.
And:
The value of a publicly traded company is only approximately represented by the value of its stock.
People often buy stock in a company at a price that doesn't reflect the company's actual value — sometimes too high, sometimes too low.
This means stocks aren't like money — their value is harder to establish.
Unlike bank deposits, stocks have no insurance against loss — an investor can lose all his money because of a wrong choice.
These facts lead to a demand for stockbrokers, people who, for a fee, will steer unskilled investors away from beginner mistakes. But there's one beginner mistake a stockbroker won't help you with — the mistake of hiring a broker.
Market Index
Professionals measure stock market performance with what is called a "market index"6Stock Market Index — a carefully selected group of stocks whose price serves as an index of the market as a whole.<br>-->. One example is the Dow Jones Industrial Average (DJIA)7Dow Jones Industrial Average — a commonly applied stock market index.<br>-->, another is the S&P 500 Index8S&P 500 Index — another market index.<br>-->, these indices serve different needs. Their purpose is to provide a measure of the overall market, rather than track changes in a single market sector or industry.
Unlike individual stocks, market indices tend to change slowly over time, reflecting broad market trends rather than short-term changes that can make a particular stock's value fluctuate in a seemingly random way.
Efficient-Market Hypothesis
The Efficient-Market Hypothesis (hereafter EMH)9Efficient-Market Hypothesis — a theory that asset prices reflect all available information.<br>--> is an idea that asset prices reflect all available information, with the implication that no one can craft a strategy to "beat the...