Make Money In Stocks

There are lots of investment myths floating around out there. One of the biggest ones I know of is the argument that a well-diversified portfolio invested over the long term will provide a secure retirement for everyone.

Turns out I didn’t have to look too far to dispel that one since my own parents were able to attest to that not being the case.

Many of their friends have had a real tough time reconciling the decisions they made decades ago and are now paying dearly for it during their “golden years.”

Nope, there’s nothing golden about seeing the majority of your wealth siphoned off by Wall Street bankers and brokers, mortgage companies, credit card companies, taxes and the ravages of inflation. Worse yet, not having enough years left on earth to make it back.

These days, people are starting to wake up and smell the coffee. They’re sick and tired of handing over their hard-earned money to snake-oil salesman and investment firms in the hopes of making a measly 5 – 10% per year… all while their nest egg shrinks year after year.

Unfortunately, the majority of Americans have a large percentage of their retirement funds in mutual funds, which leaves their portfolios extremely exposed and vulnerable. Mutual funds make money through diversification and invest in a variety of different companies across the board.

Some make money and some lose money, but the majority of them end up being marginally profitable over time.

A lot of mutual funds are sector specific (i.e. healthcare or telecom), so you can be diversified within a particular industry, but because of the high correlation between movements in stocks prices within an industry, you’re not really diversified.

The main point here is you can no longer count on traditional investments offered by the retail investing industry to meet your basic retirement needs.

Why?

Because it’s diversification in only ONE asset class: equities. That’s NOT true diversification.

Don’t get me wrong, I’m not advocating that you should all of the sudden start pulling your money out of the stock market or make any other foolish moves without first having a solid plan ready.

There’s certainly a place for equity holdings in your portfolio, but true diversification includes a good mix of both traditional and alternative investment asset classes.

Many people don’t realize how important proper diversification is and how damaging the downside risk can be. I’ll use this simple example to illustrate the seriousness of what can happen when your portfolio lacks diversification…

Let’s say you have portfolio worth $100k. If you were like a lot of people who had 90 – 95% of their money invested in equities during 2008, your portfolio lost 50% of its total value (an unrealized ‘paper loss’ unless you bailed out and sold off when the stock market tanked).

So at the beginning of 2009 your portfolio value was $50k. What percentage do you need in order to get back to where you started at $100k? Yup, a 100% return… just to get back to break even. This doesn’t even take into account the investment opportunities lost over this time.

If you run the numbers from the year 2000 through today or talk to folks who retired in 2007 based on what they thought was a “well-diversified portfolio,” chances are they still haven’t recovered.

The harsh reality is that it can take years or even decades to recover from a failure to engage in effective diversification.

There’s another popular investment myth that goes something like this; “If I only had access to 24/7 advice from “smart money investors, I’d be on the fast track to financial independence.”

Ah, if only it were true!

Lehman Brothers went bankrupt. Bear Stearns and AIG were rescued in the face of certain failure. Countless banks and even countries have been bailed out… and the list goes on and on.

Just goes to show that no one, including the banks and the government, have a crystal ball to accurately predict the future and “smart money” isn’t right all the time…

Which is why it’s important to be open to alternative investments that can beat average market returns year after year.

The reason the message of the stock market has been made to sound so optimistic is that Wall Street and the politicians who pass laws supporting Wall Street understand that to make the stock market more liquid, it needs a lot of money and large numbers of people participating in the trading. For them, that means that they need to cater to and enlist the middle and lower classes. Thus, the stock market has been made out to be the savior of people and the safety nest for retirement. For most people it is neither, and for quite a few it is the exact opposite. The market’s overall message is quite misguiding.

One of the biggest areas where people tend to be mislead is risk and how much of it there is. Once you opt in to invest in a stock, your money is at 100% risk at any given moment. In a world of wars, accidents, natural disasters, explosions, terrorism, diseases, pollution, fierce competition, destruction, and fraudulent CEO’s, no company is safe from complete collapse at any time. Even “good” companies carry this risk, as at one time British Petroleum (BP) was considered a great oil company and had actually been a good investment for decades. Even if a company does not completely implode and collapse, people can still lose a large portion of their investment from the company’s poor performance or market ups and downs.

Another unmentioned reality of the stock market is that in the end, it is a zero sum game. That means for someone to win, someone else has to lose. Typically Wall Street and insiders win first and the leftovers go to middle class retail investors.

Over the last decade there have been a few major stock market crashes. There was the Internet bubble and the housing bubble implosion. In the end, most people who made money during the good times simply lost it when the markets crashed.

While the stock market has lots of promise, it also has quite a bit of deceit and dishonest maneuvering. There is no free lunch out there and I hope small investors like myself proceed with great caution.