Tuesday, September 27, 2011

Market ups and downs

I usually don't like to comment on the stock market. There are plenty of people who do that, and I am not an investment advisor.

Nevertheless I would like to point out that the stock market is always a little bit disconnected from reality. The underlying value of the companies and the dividends they pay are only parts of what drives stock prices. Other factors are economic conditions, growth projections for individual companies, and various emotions such as fear, greed, etc.

When the Dow goes down 500 points like it did last Thursday (Sept 22), it gets some people worried. The comments on TV can sound a bit doomsday-ish (yes, I just made that word up). Then the following Monday (Sept 26) it goes up a couple of hundred points, and everyone feels much better.

The stock market generally doesn't cause the economy to do anything. Even in 1929 (despite the popular wisdom on the subject) it was not the stock market crash that caused the depression (in my opinion). The crash was only one of many symptoms of what was going on.

If one must invest in the stock market, one sensible way to do it is to choose companies that pay reliable dividends. In today's low interest rate environment, dividends are attractive because they give a much higher rate of return than interest on bank deposits. Of course there is a risk of losing your investment, whereas bank deposits are guaranteed by the government up to a certain amount.

Investing for capital gain is a whole different ballgame. Common investment advice for that is to invest in stocks for the long term when you are young, so that stock market ups and downs are evened out over the years. That generally yields better results than just putting your money in the bank. Then when you get near retirement age, get out of stocks and just put the money in the bank. That way you would avoid a possible downturn form which you may not have time to recover.

Investing to try to make a lot of money has a very common result: people lose a lot of money. In fact I would venture to say that the majority of people who invest with that motivation end up losing money. There are a few very smart people who make money at it. Then there is everyone else. A lot of people go in thinking they are smarter than the market, then learn otherwise. There are also a lot of methods and schemes being sold.

Not everyone can make money in the stock market. It's a game in which there are winners and losers. The small players are often losers.

Economic uncertainties such as those we have today can drive market sentiment. The trend of the stock market (up or down) can be an indicator of what the economy is going to do in the near future. But there are many other indicators, and no single one is an infallible predictor of the future.

People shouldn't get too excited about market ups and downs. Extreme moves may be worth noting. But even extreme one-day moves, in recent decades, have not had the catastrophic effects they sometimes seem to portend. The trend is more important than any single day.