Home > I dont get the stock market-many MANY questions in this post...

I dont get the stock market-many MANY questions in this post...

October 22nd, 2008 at 10:43 pm

Ok I don't understand stocks. I cant wrap my brain around it.I am about to knock out a few possibly wildly incorrect assumptions about the market that I use as factual. This could be a big part in my inability to understand the market. I am also about to throw out a HUGE amount of questions...

I try to understand stocks like house values. You buy one stock at $10. The more people want the stock (house), the more it is worth. The less people want the stock (house), the less it is worth.

BUT! Do stocks top out after a while? You buy a stock for $10. It averages an appreciation every year. After a few years its worth $200. yippeee! But how far up will your stock continue to climb? $1,000? $2,000? $10,000? I cant imagine many people buying one stock for $10,000.
People say to buy and hold..but if you buy and hold for 30 years wont your stock have topped out at some point? It cant keep going up forever..right?

And people tell me to not get out of the market now because I will lock in my losses. But I don't understand that either.

If I have $100 in the tanks and I have $50 in the market and I sell all. I have $50. I lost 50%.

But the stock market will do 1 of 2 things. Go up or down.

Lets say it goes down. I pulled out as it was going down. My $100 was worth $50 when I pulled out. Then the market goes down some more. My $50 could have gone down to $5.

Then the stock begins to go back up.

How would STAYING in the market ALL THE WAY DOWN have given me an advantage over pulling out halfway through the decline and putting the money back in halfway through the climb?

If the stock market is going up and I put my $50 back in...and it goes up and up. How have I locked in my losses? As long as I buy in before the $50 mark...and when the market surpasses $100- I made money, right?

But what if the market goes down to 0. Then I have no shares to go up when the market goes back up.

I guess I am wondering...why everyone wants me to STAY in the market during the downswing. I can understand BUYING into the market in the downswing. Cuz your money has nowhere to go but up. But why stay in if your initial investment is going down, down down? Why not pull out halfway through the down and buy back in halfway through the upswing. You still will have a ways to climb to get back to your initial investment. The only way you will have 'locked in your losses' is if you permantly pull out of the market in a downswing. Or if you pull out in a downswing then buy back in after the market has climbed above your initial investment amount. Wouldnt pulling out during a downswing give you an opportunity to buy MORE STOCKS than you previously owned?

If you own 1 stock and it goes down then up- fine. you own 1 stock making money. But if you sell your 1 stock for a loss and it goes WAY down...and you buy in- you can maybe buy 2 or 3 stocks for the price you sold your 1 stock!

And I was In the market during the record highs. I was in that market a year or so ago. So if I pull out of TODAYS market going down down will take a while to get back up to those record high numbers...I would have PLENTY OF TIME to get back into that climb before we reach the record highs from a year or so ago. This has taken a year to decline, wouldn't it take at least 6 months to get out of the red? So why would people tell me I will miss the jumps of the market if I pull out now? I might miss 1 or 2 jumps...but as long as I am back fully in by the time the stock climbs back to my selling point..I'm not missing anything.

I guess I wonder...if I sell when the DOW is at 10,000 points...and it goes all the way down to 5,000 points before going back long as I buy back in before it hits 10,000 points then I will be making money-right? Why should I stay in the whole time?

if I have 100 shares worth of a $10 stock- I have $1000 invested. That stocks goes way down to $2 a share...I still have 10 shares...and I wait for it to go up...and it does go $2 eventually goes back to $10 a share but I have only broken even. Everyone in the news is celebrating that the stock went up a million points but in reality I broke even. All the people who BOUGHT IN during the climb should be celebrating...but not us folks who bought years ago and just survived this whole ordeal.

And another what if my $10 stock goes down and then goes up to $100 a share...does that make me rich? I am only rich when I withdraw it right? Does that $90 I made pay me out a dividend or anything? Do I actually make money off the stock? I guess I can understand the excitement of a stock climbing if I got a cash payout every month...but I only see a return on my investment when I sell the entire stock -right?

They say the stock market historically yields a higher climb than a high interest bearing savings account so it is better to long term invest in the market...but a savings account pays me interest every month that gets compounded. It adds 3% onto the principle the 1st of every month and as long as I choose to compound the interest, I have a larger principle every month. I can withdraw some money when it is convenient, I can choose to spend the interest every month..but there is always $ invested earning interest.

That savings account money is an actual number. It is a net worth. You cant base your net worth on a stock price because it could be gone tomorrow. I thought the whole point in saving or earning money is to have security. Security to know you can put a roof over your head. To know that your kid will go to college. I can see how investing in stocks can be a way to EARN money...but I dont see how you can count your stocks as money you HAVE. Not until you cash them out.

How does a stock market come to be seen as what you are worth? How do you know you have $100,000 for retirement? Just because you had it 10 minutes ago does not mean You will have it when you retire!

But compared to a savings account once again, I get that the market on average yields something like 10% a year over the course of a decade or whatever that formula is- if I buy and hold the same stocks over the course of 30 years... but I never get to 'hold in my hands' any extra earned money (interest payment) unless I sell the whole stock. I own 1 stock for 30 years...and it is worth 10x my initial investment after 30 years...I must sell that 1 stock to actually have money in my hands and then what?-that's it. I no longer have principle in the market. My 1 stock is gone and it would cost $100 to buy it back. It would cost my entire 30 year gain if I decided I wanted to invest in the market again. It seems a one shot deal. I either own it and it is making money 'on paper' but I cant ever actually 'hold' that money the stock has earned me unless I end the game. ...

Wait. I guess the market is NOT like the housing market. Because with houses you can withdraw appreciation on your house (HELOC)..and the house will continue to appreciate! Just like a savings withdraw a portion of the account but the account remains active and continues to earn interest every month. But not stocks. You are in or out. There is no 'being invested and enjoying the fruits of your investment' until you sell the whole thing.

All those years you look at your monthly stock report and see it going up (on average) a year...but that's not really your money. It's only your money when you cash it out. And once you cash it out-it would cost you everything you just earned to get back in.

Are these ramblings making sense? Is my basic knowledge of how the market works correct? I know I am only questioning the philosophy of the market because I am losing money...but the more I try to understand why I should stay in the market, the less I understand why I should stay in the market.

12 Responses to “I dont get the stock market-many MANY questions in this post...”

  1. swimgirl Says:

    My dear, are you having wedding stress?!

    The reason to stay in now --- you are hoping for the prices to go up in the future. You don't "make" or "lose" money, really, until you sell. If you sell a stock you bought for $50 now... and the price now is $25, you LOST that $25. If, however, you wait... ride the price as it drops to $10, and then keep riding it until it starts to go up again, and eventually hits $65, and sell then, they you made $15. The trick is that there is no guarantee that the stock will rise again...but it might. And if you sell now, you've lost money for sure. No chance you'll make money later, because you already sold the stock.

    Of course, it's much more complicated than that.. but that's the idea. You don't win or lose until you sell. So you try to hold on until you can sell with a profit. Might be overnight, might take years.

    Congratulations! Enjoy your wedding!

  2. gamecock43 Says:

    I understand that- but why not sell now during historic LOWS- and buy back in when you can buy more shares? We all know the market will eventually go up. It has plenty of room to go down right now...but it has even more room to go up.So will go up. But when we KNOW its going down, Why am I being told to stay in it? WHY cant I sell now and buy back in when its lower? I thought the way to win this game was to have as many shares as you can. If you buy a share and ride it up and still have 1 share. Why not look at this as: you buy a stock as a 'holding stock' to sell during a dip and multiply that stock when you reinvest? Why buy and hold?

  3. scfr Says:

    Quote (Question): "Why not pull out halfway through the down and buy back in halfway through the upswing."

    Answer: Because no one knows for certain when we are halfway through a downswing or when we are halfway through an upswing. We only know that in hindsight.

    If you really feel absolutely certain that stock prices are going to continue to fall, then yes, you could sell now and buy back later. But what if you are wrong and prices start to rise immediately after you sell, and it turns out you sold at the bottom? Is that a risk you are willing to take? Nothing wrong with gambling (market timing) as wrong as you are willing to accept the consequences if you are wrong.

    I feel for you, really I do. The money I have in the stock market, in the form of mutual funds, was invested gradually over the years (through 401K and IRA contributions). That has given me the benefit of dollar-cost averaging, which means I have been buying more shares when the market dips, and fewer when the market climbs.

    As I recall, your stocks were purchased in one fell swoop, following an inheritance. Okay ... That's done; it's in the past. You can't go back and dollar-cost average your inheritance in to the market now.

    Although you may actually be "dollar cost averaging" a bit without realizing it. When your mutual funds pay a dividend, are they reinvested (used to purchase additional shares)? If that is the case, then you actually already are buying more shares when the prices are lower, and buying less when prices are higher. If you're not sure what is happening to your dividends, look at your statement or ask your financial advisor.

    Anyway, as I was saying, what's done is done. My suggestion is that you seriously consider leaving the money you already have invested just as it is, and focus instead on how you want to invest any new money going forward.

  4. monkeymama Says:

    I think you read the article I posted recently - and it explains why. You generally end up selling a lot lower than you buy back in. It's just human nature.

    More importantly, and what the articled I referred to re-iterated, is that the biggest stock market gains (& losses) are only over a handful of days. So you'll likely miss the best market gains if you sit out any period of time. It's risky.

    Anyway, stocks also split. Say a stock goes up to $100 per share. It's getting expensive. The stock splits so now everyone has twice as many shares at $50 per share. Some mutual funds and stocks do not split. I actually own a fun that is $500/share - I don't think they have ever split it. It is pretty psychological. The end result is the same amount of money invested when there is a split. There can be 2:1 splits, 3:1 splits, etc. IF they never split, some stocks could certainly be quite expensive.

  5. scfr Says:

    In paragraph 3, I meant to say "... as LONG as you are willing to accept the consequences if you are wrong."

  6. gamecock43 Says:

    Ok...monkey Mama and SCFR...I didnt know that mutual funds give me dividends and that expensive stocks split. Those are 2 reasons I would WANT to stay in the market! (I knew I was missing important facts!)...and I did not know that highs and lows are only a few days apart. I know that the recent drop and rise was a few days apart...but the market has been slowly declining a year now and I figured it would go back up in that time frame as well.

    But even though we had that GREAT DAY a few days ago...we still never caught up to where it was before the SCARY day a few days before that. So if I pulled out BEFORE the scary day and invested after the GREAT day, I would still be buying in cheaper than when I cashed out.

  7. jIM_Ohio Says:

    And another what if my $10 stock goes down and then goes up to $100 a share...does that make me rich? I am only rich when I withdraw it right? Does that $90 I made pay me out a dividend or anything? Do I actually make money off the stock? I guess I can understand the excitement of a stock climbing if I got a cash payout every month...but I only see a return on my investment when I sell the entire stock -right?
    I think you are getting overwhelmed by volatility. Seing $10 turn into $6 overnight... yet you probably have not seen the $10 turn into $12 or $13 yet. That does happen.

    In addition- savings account might pay interest at 3% and pay it monthly, but it is really paying 3%/12 per month, not 3% per month. The 3% is an ANNUAL return paid monthly (so you get 1/12 of your return each month).

    If a company has a stock, that is ownership in a company. A company will then be valued as "market cap"- which is the value of all outstanding shares of stock.

    Microsoft is my favorate example- MSFT is worth 196 BILLION dollars. It has a stock price today of $23.85. It has issued 824 million shares of stock. If you multiply 23.85 by 824 million, you will see the market cap.

    This is important because when microsoft issued stock, that is what made Bill Gates rich. Bill Gates owned the company and really only had the income from the company to generate his wealth. When Microsoft sold stock it went public and they may have decided to sell 100,000 shares of stock at an initial price of $50. That established that Microsoft is worth 50*100,000= $5 million and the company then had $5 Million cash added to its bank account for the part ownership.

    Let's say you owned 10 of those shares at $50 ($500 investment). Then MSFT stock went up to $120 (you now have $1200). The company might have decided that stock price is too expensive, so they did a 3 for 1 split. The stock prices divides by 3 and you get 3X as many shares. Now you own 30 shares at $40/share (still $1200). The $40 goes up to $100 again and this time stock splits 2:1 so now you get 60 shares and each is now worth $50. Stock might go up to $60 then split 3:1 again. The 60 shares turn into 180 and stock price is reduced to $20.

    Then Microsoft decides it has too much cash (good problem to have). So they decide to pay a dividend. You have 180 shares of stock worth $20. Microsoft decides to pay a $.01 dividend per quarter ($.04 per year). So on the date before the dividend you have
    180 shares worth $20= $3600
    when the dividend is paid out (.01) you now have
    180 shares worth $19.99 and 180*.01=$1.80 cash
    in 3 months the same dividend is paid
    19.99 becomes 19.98
    still have 180 shares, so same $1.80 is paid to you
    you still have $3600, depending on what you did with the cash.

    If you choose to, you could reinvest the dividends. This means when MSFT pays you the $1.80 you buy stock. That means you could buy $1.80/19.99=.09 shares the first dividend.

    When the second dividend is paid you get 180.09*.01=$1.8009 paid to you. Eventually you will have fractional shares which increase the $1.80 paid to something much higher.

    2 things happen here-
    1) each time a dividend is paid, the stock price decreases by the amount of the dividend
    2) the stock price does not stay the same between dividend payments (it might, but probably not).

    So yes- a stock could pay you back if you choose the right ones. Typically dividends are paid by larger companies which have established businesses. Proctor and Gamble, Microsoft and General Electric are three excellent examples. Many other companies (like Oracle, Cisco and similar) do not pay dividends.

  8. Merch Says:

    The question to ask yourself is how do you value a company. What is it's value? Assets- liabilities? present value of future cashflows? A multiple of P/E? Is the stock market cheap or expensive now?

    IBM just had a great quarter. VM Ware had a great quarter. And these stocks are down.

    Personally, I was looking at the dow testing of 8,451. It held up. I talked to BA about the market starting to flag or create a trading channel.

    Warren Buffet is buying everything he can get his hands on. The credit markets are starting to ease and everyone is talking corporate profits now.

    This is a huge step forward. I mentioned to watch the VIX for market volatility. I think it's hit a ceiling at the moment.

    Is the market going to go down to 5000? I don't know. But I am betting that by end of 2010 and 2011, we will be significantly higher.

    As the saying goes, "Be fearful when others are greedy, and be greedy when others are fearful."

    I like Buffet have been getting greedy. My advice, from my heart, forget the market enjoy your wedding and we'll talk when you get back.

  9. Merch Says:

    Last thing about savings accounts - you have to subtract out inflation to get true earning of your money. If you are earning 3% and inflation is at 3.5 %, you are losing 0.5% a year.

    Take a deep breath and enjoy the wedding!!! Oh, and count your blessings. It's ok to have fear, but don't let fear control you.

  10. Stock Research Says:

    Great post and good questions. My comment here might seem obvious, but it helps to look at your stock market investments as what they really are, small pieces of businesses that you have selected on their merit. I think people spend too much time thinking about "the market" rather than the companies in which they are invested. Other than needing the money, you should really only abandon a stock if you have lost faith in the company or if the stock price indicates it has appreciated to where it is overvalued.

  11. gamecock43 Says:

    very good advice. And I like your microsoft example Merch...I didn't know that some companies do pay dividends and profit so well. Though I have heard Microsoft is something of an anomaly in history.
    I guess I worry because I don't really know what I am invested in. The IRA was in place when I inherited it. I figured what was good for the parents was good for me and didn't touch it. Now I guess it's time to back track and analyze individually each piece of the IRA. Or I could leave my advisor to do that, but I want to take responsibility for this IRA.

  12. Broken Arrow Says:

    gamecock, don't you have a wedding to attend to?

    Since you've gotten plenty of response on your questions so far, I'll just skip over that part.

    The thing to keep in mind is what SCFR said. We really don't know what will happen next. Not really. I mean, we scour all over for the place for clues on where we might end up next, but in the end, nobody really knows.

    Try this exercise right now. Take out a Post-It note or something. Write down the number where you think the DOW is going to be by the end of December. Or even the beginning of December. And if you're feeling adventurous. Write down the reasons why you think it'll be that number.

    But as you sit down and think about it, I hope that's when it'll really sink in why, ultimately, no one can predict the future.

    Does this help make things clearer? Your ideas are fine IF you know what's going to happen next. Yeah, sometimes, we do catch a lucky break and know or believe we have a pretty good idea of what will happen next. But for the most part, no one really does.

    That's why so many talking heads on TV have such lively conversations and debates about the economy....

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