Stock Market Myths: 7 Ways a Fool and Their Money Are Soon Parted

By Markets Fool.com


Source: Flickr user thetaxhaven.

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The stock market may be something of an enigma for a number of American households, but historically it's been a substantial creator of wealth for those who choose to partake in investing.

Historically, the stock market has returned around 8% per year, which using some quick math could allow you to double your money every nine years or so. Investing with some regularity should, on paper, allow you to retire comfortably.

But, there are a number of stock market myths that stand at the ready to throw investors off their game and keep them from building wealth and retiring on their own terms. Today, we'll take a look at seven of the worst stock market myths in the hope that you can recognize them in the future and avoid falling victim to their allure.

1. "In order to get better returns, you have to be willing to take more risk."
One of the most pervasive stock market myths is that in order to maximize your returns you need to be willing to take more risks. In other words, you can buy safe blue-chip stocks that are growing by a few percent a year, or you can go for the gusto by investing in companies with cutting-edge technologies and products.

While a few of these high-growth, high-risk stocks do wind up paying off for investors, taking more risk as a whole doesn't always equal a greater reward. Take a look at market maven Warren Buffett as a good example. His entire investment philosophy revolves around minimizing his risk and buying safe companies whose products practically sell themselves. You'd be hard-pressed to debunk the idea that you can't get rich by investing in so-called "safe stocks" once you've learned about how Warren Buffett made his billions.

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Source: Federal Reserve Bank of New York via Facebook.

2. "History always repeats itself."
I'll give investors an inch here and say that to some degree history does repeat itself no bull market or bear market lasts forever. Just like a broken clock is right twice daily, forecasters will at some point be correct that the stock market or U.S. economy has hit a temporary top or bottom.

But, history is far from a certainty to repeat, otherwise we'd all be looking to the past in order to get rich in the present. For instance, what caused the last economic downturn is unlikely to be the cause of the next economic bubble bursting. Investors need to accept the fact that there's a lot they'll just never be able to accurately predict and time the stock market when it comes to investing.

3. "Penny stocks can double in value easier than a large-cap stock."
This is one of those myths that sort of makes you bang your head against a wall. The idea here is that it's a lot easier for penny stock or small-cap stock to double in value than it is for a stock with a higher share price or market valuation.

In reality, everything comes down to Wall Street's and investors' perception of a stock. If investors believe a stock is worth twice as much as it is now, then the stock in question is potentially going to double whether it's $100 a share or $1 a share.

In fact, penny stocks can be potentially dangerous for investors as institutional investors tend to shy away from investing in single-digit share price stocks. Additionally, reputable listing exchanges such as the NYSE and Nasdaq could move to delist companies from the exchange if they don't meet the minimum listing requirements (i.e., a share price above $1).

4. "Only stock brokers, Wall Street analysts, and the rich can make money in the stock market."
As with "history always repeats itself," I'll give this myth a small amount of room to breathe in that more tenured investors and money managers who have a plan with their money and stick to their plan do have the potential to outpace the broader-market averages. However, to say that brokers, analysts, and the rich are the only groups that can win in the stock market is a boldfaced myth.


Source: Flickr user www.vpsi.com.

According to Bankrate's Money Pulse survey from April, some 48% of American adults have money invested in the stock market and they can't all be losing to money managers. In fact, the individual investor could hold one unique advantage over money managers. You see, money managers and analysts are under constant pressure to "dress" their portfolios with winners and to outperform quarter after quarter. This can lead to a lot of active buying and selling. The individual investor is only competing against his or herself, meaning they have the opportunity to stay invested over the long-term and outperform Wall Street using the luxuries of time and compounding gains.

5. "What goes up, must come down."
Here's a news flash for you: what goes up can actually stay up if the technology, product, or service behind the optimism can meet or continue to exceed investors' lofty expectations.

To be clear, there have been instances in the past where "what goes up, must come down" has panned out. The biotech bubble and dot-com bubble of the early 2000's, and more recently the bursting of metal stock prices and even 3-D printing valuations are good examples. But, if stocks that go up always come down, then how would you explain Apple, Wal-Mart, or Johnson & Johnsonwhich just seem to go up, rest for a bit, and then go up some more? The answer is you can't explain it because history doesn't always repeat, you can't accurately time the market over the long run, and good companies do actually exist!

Long story short, just because a stock has risen doesn't mean it's going to come back down. You need to be able to analyze the underlying business model of a company to determine if there's actually a reason for its stock to retreat.

6. "Dividend stocks are incapable of delivering a high rate of return."
The thinking here is that companies which pay their shareholders a dividend are often in the mature portion of their growth cycle, and as such should see their stock price advance at a much slower pace than companies that don't pay a dividend and are reinvesting back into their business. The long-term reality, though, couldn't be further from the truth.

Source: Pictures of Money via Flickr.

According to historical researcher firm Ned Davis Research, and as noted by Forbes, between Jan. 31, 1972 and Jan. 31, 2013, companies that initiated a dividend or increased their dividend had an annualized rate of return of 9.7%. By comparison, stocks which did not pay a dividend over this same time frame had an annualized rate of return of just 1.8%. That may not sound like a huge difference, but adding $100 per month to dividend-paying stocks (based on the Ned Davis Research average) over the course of 41 years would have netted you about $430,000 more than the non-dividend stocks.

Don't forget that dividends are a waving beacon to investors of the health of a business' long-term business model and cash flow.

7. "Popular products make for great investments."
Finally, there's the idea that popular products will undoubtedly become great investments. There's some degree of truth to this like some of these previous myths, otherwise we wouldn't see it here. Products like the TeslaModel S or Facebook are extremely popular with the public, and both companies have made for excellent investments.

But, sometimes it takes more than a great product to lead to a great investment. A company needs to have a good management team and be able to make money in order for its stock price to advance. WebVan offered a great service shop online and have groceries delivered to your home and raised $375 million in its 1999 IPO. However, its $6 billion valuation made little sense next to its $5 million in full-year revenue and the $27 it cost, on average, to fulfill a consumers' order. Not surprisingly, just a few short years later WebVan went bankrupt.

The lesson here is simple: great products lead to great investments only if there's a clearly defined path to profitability.

The article Stock Market Myths: 7 Ways a Fool and Their Money Are Soon Parted originally appeared on Fool.com.

Sean Williamsis short shares of Tesla Motors, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool owns shares of, and recommends Apple, Facebook, and Tesla Motors. it also recommends Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.