Two Most Common Misconceptions About Stock Investing

Investing is simple, but not easy.

Warren Buffett

Regularly, I speak with many people about stocks, and I found that most people have at least one of these two most common misconceptions about stock investing:

1. You want stocks to go up.
2. If you invest in a great company, you will do well.

If the above sounds like they make sense to you, that’s because these statements are partially true.

Let me explain by briefly telling you about conversations I’ve had regarding each of them.

Conversation #1

As my oldest daughter, Sophie, is soon graduating middle school, I reminisce about her childhood. One of things I clearly remember was a great conversation I had with her when she was six years old.

It was her first investing lesson, and it went like this:

Sophie: Dad, what do those red and green things mean with your stocks?

Me: Red means the stock went down and green means the stock went up.

Sophie: Red is not good!!!

Me: Not necessarily. Let me ask you, would you like to buy a toy for one dollar or two dollars?

Sophie: Uhm, one dollar!

Me: So, if you wanted to buy a stock, would you like to buy it at a higher price or a lower price?

Sophie: Lower!

Insight #1:  If you have a long-term horizon, you want stocks to go down.

Benefits of Lower Stock Prices

Unless you need to sell stocks in the near future, lower stock prices can benefit you in several ways:

1. If you regularly save money every month, leaving it in cash usually isn’t the most efficient allocation. For most people, depending on their situation, investing at least some portion of their monthly savings into stocks is usually a good idea. If you are continuously buying something, you want the price to be lower rather than higher. For example, do you want to fill up or charge your car with higher gas/electricity prices or lower?

2. Even if you don’t save money every month, it is usually advisable for most people to have some assets in defensive investments such as cash, money market and bonds. If a large market correction occurs, investors who are strategically holding cash can buy stocks at a bargain and can obtain above-average returns.

3. Even if you don’t save money every month or are fully invested all the time, a lot of companies repurchase their own stock. Again, as long as you have a long-term horizon, these companies that have stock buyback programs will be worth more over time if their stock purchases are executed at lower prices rather than higher prices.

If my 6-year-old daughter can understand why a buyer of stocks should want stock prices to be lower, anyone can!

Conversation #2

Two months ago, while our family was evaluating various homes to move into, we came across a realtor who complained that his stocks (Tesla and Apple) were down that day.

I told him that’s what stocks do, they go up and they go down. He continued to complain, so I asked him if he had figured out the value of both stocks before buying them?

He said, “No, I don’t know how to do that, but they are great companies, so I thought it would be ok just to buy them.”

I responded, “Just like in real estate, would you ever buy a property without trying to value it?”

He had no response to that.

Insight #2:  A great company does not equal a great investment. The price you paid for it matters.

The “Nifty Fifty”

In the early 1970’s, a group of 50 stocks were quite the sensation, they were called the “Nifty Fifty”. These 50 stocks were the highest quality companies during that era. Examples are Coca-Cola, IBM, Disney, Proctor & Gamble, McDonald’s, etc.

I recall reading that if you invested at the peak of 1972, you would have needed 15 to 17 years to breakeven if you invested in the Nifty Fifty.

I did a quick Google search and couldn’t find a source for my numbers, but when I typed a query into Gemini (Google’s AI search) it said, “Even with strong subsequent earnings growth, it took several decades for many Nifty Fifty stocks to reach their 1972 peak price again.”

But What About Microsoft?

In 1999, when the Dot Com Bubble was in full swing, one can argue that Microsoft was the highest quality company. Well, if you invested in its stock in 1999, it would have taken you 15 years to breakeven. This is despite earnings growing significantly during that period.

Data source here.

Better Investors…Together

I hope these conversations and insights help you become a better investor.

At WealthArch, in order to properly assess a company’s intrinsic value and price, we scrutinize each quarterly and annual report, listen to quarterly earnings calls, review the proxy statements, and keep track of ongoing company/industry events and disclosures.

Most small, independent financial advisory companies don’t personally do the large amount of quantitative and qualitative analysis that we do. To learn more about our investment approach, please click here.

If you need help structuring your portfolio to capitalize on the next downturn, please contact us.

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