There are so many myths and falsehoods told about the financial markets that it’s a wonder any new investors ever venture into the world of stocks and shares at all.
Whether it’s the idea that only rich people with expensive brokers can afford to participate, or that only experts with specialist knowledge can benefit from the market, these misrepresentations serve to deter curious would-be investors from what is an excellent form of investment.
Here, we’ll tackle one of the most pernicious lies about the stock market – that it’s just another form of gambling – and examine why investing in stocks and shares can be so ultimately rewarding.
Why Is The Stock Market Not Gambling?
Assuming that anything that contains an element of risk is equivalent to a form of gambling is a mistake that so many of us are prone to make. This couldn’t be more obvious than when it comes to investing in the stock market, with some people describing it as little more than one giant casino.
But these prejudices are entirely baseless, and only serve to scare off potential investors from something that can be a wonderful wealth generator, not to mention a great way to save for retirement.
The most glaring fallacy about this kind of thinking is not recognizing that investments in stocks are not a one-time bet on the outcome of a single event – like in a horse race, for instance – but rather a purchase in a real thing that you ultimately own and can sell on at a later date.
This means that the time horizons involved in investing and gambling are totally different. Indeed, buying shares in dividend paying stocks also entitles you to a portion of that company’s profits, not just the capital appreciation when those stocks rise in value.
Furthermore, investing isn’t a zero-sum game like gambling is. When the stock market goes up, for example, everyone’s a winner – which is never true for betting, which always requires a winner on one side and a loser on the other.
In addition to this, the stock market creates value for society, helping firms raise capital to develop their companies, which in turn spurs the invention of goods and services which enrich society.
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History Of Stock Market Performance
Investors seeking profitable investments for their capital deposits have often turned to stock market tracker funds as a way to provide predictable and stable incomes over the long-term.
One of the most famous of these is the S&P500, which, with a history dating back over 100 years, makes gauging the kind of yearly income you can expect from an investment in it that bit more accurate.
Taking the performance of the S&P500 from the time it formally adopted the concept of 500 companies as its standard 65 years ago, the index has returned an average 10.59% per annum – or 69,516.59% since its inception. That means that if you invested $10,000 in 1957, you’d have almost $7 million today.
As you can see, compounding the yearly gains you make from your investments is important, and we’ll come back to this topic later on.
“S&P 500: A Bet On America” Warren Buffett
In February 2019, famed investor Warren Buffett went on CNBC to give a wide-ranging interview on the occasion of the release of his latest annual letter to shareholders.
In it, Buffett made the now-notorious claim that “there’s been no better bet than America.” In fact, Buffett clarified these remarks to say that most investors should just put 90% of their money put in an S&P 500 index fund, and the remaining 10% in government bonds.
These comments are no doubt scandalous, not least to the thousands of investors in Buffett’s own Berkshire Hathaway investment vehicle who rely on him to grow their capital for them. But the Oracle of Omaha has never been one to sound his own trumpet; Buffett even stated in that same CNBC interview that most of the time he doesn’t know how to pick the best stocks himself.
So why does Buffet have so much faith the S&P500 to begin with?
At its essence, the S&P500 has a kind of self-correcting mechanism built into it, one which makes it so hard for passively-managed, and even actively-managed, hedge funds to beat.
The reason for this is that the S&P500 is an index of the biggest and best performing companies in America; that is, if a stock begins to under-perform – and subsequently fails to satisfy the selection criteria laid out by the Standard & Poor’s selecting committee – the business is pruned from the list and ultimately replaced by a more suitable one. In fact, you could say there’s a kind of “survival of fittest“ element to the S&P500.
And unlike other purely rules-based indices, the S&P 500’s human filter – all new company additions to the index must be ratified by committee, as must all de-listed ones too – ensures that no aberrant or untimely changes are made to the index.
Indeed, the S&P500 is reconstituted on a quarterly basis, but measures are taken to limit turnover due to a decline in a constituent company’s market value. The market crash at the outbreak of the pandemic would be a good example of why this is important.
How Reinvested Dividends Can Make You Rich
Done correctly, dividend investing is one of the most secure and rewarding forms of investing there is. With the right combination of stock picks and strategy, dividend yielding income has the ability to compound over time, generating plenty of cash from your portfolio with the minimum of effort.
Critical to this approach is the idea of reinvesting your quarterly dividends back into your dividend paying stocks. Because dividends are issued on a per share basis, using your dividend income to buy more dividend paying shares increases your overall dividend haul next time it comes to be paid. Repeating this every quarter leads to a compounding effect that serves to increase your cash flow essentially indefinitely.
In addition to the compounding of your returns – and an increase in your income streams – reinvesting your dividend pay-out is also cheap and efficient. You won’t be charged any commission or fees when you reinvest, and you can set-up a reinvestment plan that is automatic and requires little further oversight on your part.
How Wealth Compounds Over Time
Just as dividend reinvestment works to compound your gains, so too does any other investment that grows positively over the course of time. The stock market is an obvious example of this, but there are other investment vehicles and products that do the same. Treasury Inflation-Protected Security options are a good alternative, as are Real Estate Investment Trusts and other income-producing property investments.
On a purely mathematical level, compounding works because the periodic interest, or increase, on your principal capital is added to that initial amount, which then earns more interest on this newer, larger sum, and so on ad infinitum.
Compounding is a key concept in successful investing: indeed, none other than the great Warren Buffett has likened it to a snowball growing bigger as it rolls on down a hill.
Can Stocks Make You Rich?
You’ve heard the phrase that “timing is everything”? Well, that couldn’t be more true when it comes to buying stocks.
You see, those earlier numbers we quoted at the beginning of this article on the performance of the S&P500 come with a one huge, major caveat. That is, the date at which you enter the market has a massive impact on the magnitude of returns you receive further down the line.
For instance, if you bought into the S&P500 during the 2000 bubble, before the market was in a downtrend, you would have significantly worse returns than if you’d opened your position at the bottom in 2002, just as the market began to rally.
Another thing to consider if you’re building your own portfolio is whether you’re actually making the right calls on a consistent basis or not. Yes, Warren Buffett did say that “you can bet on America,” but he also said that “you have to be careful about how you bet.” The markets are inherently unpredictable, and navigating those waters on your own can be tricky.
But with those disclaimers aside, investing in the stock market can, and should, make you rich. There’s ample evidence of that – and on the occasions when some investors get it wrong, their mistakes can serve as a teaching lesson going forward.
Is The Stock Market Gambling: The Bottom Line
Investing in the stock market is a time-tested way to make your money work for you. It provides a hedge against rising inflation, and offers all the upside that generous compounding effects can bring, without the risk of total losses from zero-sum activities like gambling.
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