I used to wonder how the stock market works. After all if everyone trading stocks is rational how can so much money be made and lost? However, so many diverse people and organizations own stock that they are always buying and selling and not necessarily for the best reasons.
I was having lunch with a friend the other day. He works in a large bank and employees are compensated with stock via their 401(k) program.
One of his coworkers was quite upset that the stock price was so low. She decided that it was time to sell. My buddy tried to advise against this, but his co-worker was bent on selling her shares. My friend, not wanting any more involvement, politely told her that she should do whatever she thought was best.
She sold at $20. The next day the company she worked for announced better than expected earnings and the stock rose to $25. My buddy tried to explain the sound his coworker made when she discovered that fact. Sort of like a shrieking cat, I believe.
On top of that the company announced an increase in dividends (of which she would be receiving none). This lady had been employed for close to 20 years. We're assuming she had a lot of stock.
The Democratization of the Market
What's the point? More people than ever are in the stock market. 401(k) and profit sharing plans have introduced stocks and bonds to a larger group of Americans than ever before. Many people that would otherwise not even think about investing in the stock market.
The lady in our story didn't understand buy low, sell high. She only understood fear. Even after this expensive lesson, I'm sure she blames someone else for her mistake. The president, congress, oil prices, I'm sure all of those got the blame.
A Whole New Group of Suckers
It is assumed that stock ownership for everyone is a good thing. It sounds good and it makes people feel good. We are now an "ownership society."
However, just as handing a loaded gun to child does not make him a marksman; giving stock to people does not make them investors.
So many of these newly minted "investors" are driven by fear. They don't really understand the market (does anybody really?) and they get their news from the TV and radio. These folks get their statements in the mail and see that they've lost money (on paper of course). They know they need to stop losing money and the only way to do that is to sell now. It's as if someone is reaching into their back pocket and taking the money right out of their wallets.
Poor Education
I'd estimate that about 25% of Americans can balance their checkbooks. I'd bet far fewer can read a financial statement from their investment company.
My number one rule of investing? Understand what you're investing in. My relatives can't tell me why the lost or made money in the market. They only know it's down so they "lost" money. Even as I attempt to tell them they've only lost money if they sell now and lock in their loss, their eyes glaze over and they prefer to talk about sports or the weather.
And that's the problem. When you don't understand something, you have no business investing. Many of today's "investors" should be in Treasuries, CD's and savings accounts, not international growth funds. But what about the returns you ask? What about the return? When you buy high and sell low, your damned sure not getting a good return.
Every time we extend ownership (sub-prime mortgage fiasco, Fannie Mae, Freddie Mac) to those that don't deserve it, we end up with a big mess.
With the 401(k) Congress has handed a loaded weapon to the investing children of America. The bad decisions of these people will continue to drive the market. When all signs point to buy and someone sells on fear, that trade is keeping the market fluid. And that's how the stock market keeps working.
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