The stock market might be one of the most misunderstood concepts in the world. Given its central role in helping investors become financially independent, it’s crucial to understand what it is, what it isn’t, and how it functions.
Unfortunately, rather than playing the role of educator, the financial media have a vested interest in focusing on sensationalism, short-term events, and fear-driven stories. In this article, we’ll bring the important concepts back to basics. We’ll unpack the various stock market misconceptions and provide a clear framework for thinking about the stock market on your investing journey. We hope this will help you observe the world through a new lens and become a more mature and successful investor.
The Wrong Way to Think About the Stock Market
Many investors consider the stock market an abstract concept they cannot see or interact with. With this mindset, it’s easy to start thinking about stock ownership as a piece of paper. You hope that one day it will be worth more than it is today, but it’s not clear why that will happen. Investors with this understanding are essentially hoping for the best, and when results do not match their expectations, they will develop resentment towards the market as a whole.
Another group of investors have a cynical view of the market as nothing more than a casino in which the game is rigged in favour of “insiders”. They view wealth as something that can only come at the expense of others—a zero-sum game, as it were. With numerous examples of nefarious activity by those involved in financial services, it’s tempting to take this view. However, long-term success is not likely for someone operating within this framework.
Ultimately, without a proper understanding of the stock market, these investors are likely to remove themselves as stock market participants, and those who do invest are unlikely to behave in a disciplined manner when market volatility inevitably arrives. Both scenarios will severely damage their chance of becoming financially independent.
The Right Way to Think About the Stock Market
The first step towards correctly understanding the stock market is to become aware of the companies you interact with daily. From the moment you wake up, you consume goods and services produced by businesses. Many of these companies have their shares listed on public exchanges, making them available for purchase by any investor. While some investors buy these shares directly, the average investor becomes a stock owner when they invest money in large investment funds.
Through their management and boards, these companies are incentivised to increase the revenue and profits generated by their products and services. They use these profits to re-invest in attractive opportunities or distribute the money to shareholders as dividends.
And so, when you buy from a listed business, you indirectly send money back to its investors. You likely are one of them. A walk down any high street will see you coming into contact with dozens of listed companies. The stock market, therefore, is nothing more than a collection of these companies. It’s real companies selling real things to real people.
The aggregate stock market value quoted in the media is the best estimate of the market’s future value as arrived at by the millions of market participants, and it’s a marvel that we can participate in the economic potential of the capitalist society we live in.
Long Term Success Is Inevitable
Success in the investment markets comes down to good investor behaviour, and good behaviour only comes from correctly understanding the fundamentals. Typically, investors carrying around misconceptions about the stock market make poor decisions that result in financial loss, while investors with a mature understanding invest for long periods with confidence.
Your best starting point for interacting with the stock market is to remember that you are the stock market. It’s all around you. You contribute to it, and you benefit from it. You own the great companies of the world; what a marvel!
While short-term sentiment will ebb and flow among professional investors, you can take comfort in the fact that over more extended periods, the market increases due to higher corporate earnings and dividends. If you have the fortitude to stay disciplined during the inevitable (but temporary) downturns, you will experience lasting success.