Hi. My name is David Hood from ‘Beginner Investing Made Easy’. Today I want to talk to you about ‘Learning about the stock market’. It’s easier than you think. There are three major steps that will take you a long way in helping you learn about the stock markets quickly and understanding it so that you make good decisions.
1st Step: Great Books.
Find great books. If you read these three books you will be way ahead of most people. The first one is called ‘Learn to Earn’ by Peter Lynch. It is part of a three book series — this one being the first one. What makes this book so great is that it goes into the history of the stock market. Although it might sound boring, this is critical because it shows you past patterns that help you understand that you do not need to worry if they repeat themselves because they are expected.
The 2nd book is ‘A Random Walk Down Wall Street’ by Burton Malkiel. It talks about how most of the mutual fund managers and stock pickers are as good as throwing darts at a dartboard and just picking randomly. The main point it makes is that 80% of mutual fund managers lose out to index funds. The book promotes index funds — which I am a big fan of.
The 3rd book, which I consider the best one on investment, is ‘The Intelligent Investor’ by Benjamin Graham, who was Warren Buffet’s mentor from many years ago. The book is about value investing and focuses on that specific class of stocks. However, there are many pieces in this book that apply extremely generally across investing in the stock market. The book is sure to change the way you view investments and will make you a better investor.
2nd Step: Understanding.
Understand the stock market. Here is where ‘Learn to Earn’ comes back. You need to understand the history of the stock market to be able to understand what is expected in the future.
There are constant highs and lows in the stock market. If you understand and know about the history, you won’t freak out and think that it won’t come back up when you see a low happen. When you see a high, you’re not going to think like many people did in the late 1990s and early 2000s that the stock market would continue to go up. It helps you to keep your emotions, which can be your own worst enemy when it comes to the stock market.
The second is to understand human psychology, so you can understand your own weaknesses. This might sound a little weird, but it’s actually critical because you need to understand that our brains give us the wrong clues when it comes to the stock market. For example, when you see a sports team and it’s been playing really well lately, you expect them to continue to play well. That makes sense and it’s actually accurate. However, when you see stocks that continue to go up that doesn’t necessarily mean that they will continue to go up and that you should invest in them. In fact, it often times means the opposite. If you buy after they’ve gone up a lot, you’re buying high. When a team is doing really poorly, you expect them to continue doing poorly. The same is not always true for stocks. It’s probably more true for individual stocks than it is for a stock market in general. However, you need to understand that your emotions are pulling you very strongly when it comes to these extreme highs and lows, and our instincts are always pulling us into making the wrong decisions so understanding human psychology is very important.
You should also understand the health metrics of a company or the stock market in general. The two most important being Price To Earnings Ratio (aka PE Ratio) and Earnings Per Share (EPS). Learning those will be helpful to understanding not just the stock but the stock market as a whole.
3rd Step: Doing
The 3rd step is to do it. I would recommend starting small, so you feel the emotions but you learn about yourself and how you react to things without risking too much. So start small, don’t invest too much at first, although it will be hard. You really need to understand that your human psychology will be to cover losses by investing more. Part of starting small is learning about yourself. You need to focus on how you’re responding and being objective so that you can create a plan that fits your personality and emotions.
Have reasonable expectations. Overall you should expect a 10% compounded annual growth rate before inflation. After inflation it will actually be 7%. This might sound low, but it’s because many people think you can continue to make 20% or 25% on stocks over and over again because that’s how the movies portray it. But there’s only been one or two people who have been able to do this. For example, Warren Buffet, but don’t try to replicate his success. He’s a genius and he works on this 80 hours a week. So only if you’re a genius in economics and you have 80 hours to spare, your expectations can go up. For the rest of the 99%, don’t expect too much. When people expect very high returns they take extreme measures, make wrong decisions and end up with much lower returns.
My final point is to be objective about the results. Sometimes you can make the right decisions and get the wrong results and vice versa. You can invest in a hot tip and actually triple your money. That doesn’t mean you made the right decision. If you do that constantly, eventually it’ll catch up with you and you’ll lose overall. Furthermore, you can make a really good investment and it might not work out. There is always a bit of probability that you will fail, especially if you’re investing in individual stocks. A way to minimize risk is through the use of index funds, which spreads out risks across many stocks. Although you won’t have as high a return in 6 months time, your stock is not going to drop down to zero and your risk will be much lower.