Lesson 12

Stock Market Expectations

When people become interested in investing for the first time, they often have crazy expectations with regard to how much money they will make from the stock market.

It’s fairly common for people to think that they can double their money in a year or even better.

A flaw of human psychology is the desire to get right quick, a concept that has only exacerbated over recent decades due to technological advancements that have made things in our lives more efficient and readily available.

When it comes to investing successfully, patience is required as it often takes a long time to turn a small amount of money into a very large amount of money.

What is a normal return from the stock market?

In finance, a good return is seen as a return that outperforms the market as a whole.

So, if the S&P500 makes 10% a year for investors on average, having a return that is above 10% is considered to be good.

10% is a relatively small percentage, which often surprises people as they assumed that investors made 100% or more in a year.

The truth is, if you invested $1000, achieving a $100 profit in a year is considered to be the standard.

As this number is reasonably small, many people start to question the value of investing, especially if it’s going to take a long time for big returns to be achieved.

This is exactly why a large proportion of society are not investing in the stock market. A lot people have the perspective that unless they get rich within a short period of time, it’s not worth it.

Should I worry about a stock market crash?

Another concern that new investors tend to have is if they experience a stock market crash. The reason is that they worry about their investments going down in value.

It’s often very difficult to predict when a stock market crash might happen and few investors are able to do it successfully, even professional investors.

The standard advice from the professional community is to do nothing during a financial crash because the markets will very likely stabilise in the long term. 

As long as you hold a long term perspective, stock market crashes should be seen as an outlier across the years that you invest. These stock market conditions are temporary and often resolve themselves in the short term.

It may surprise you but most professional investors get excited over the prospect of a stock market crash because it allows them to purchase stock at incredibly low levels, prices that may not have been seen for several decades.

So to some extent, you should try to look at stock market crashes as if they are an opportunity to buy stock at incredibly low prices. The assumption here if that you have money to invest, which is not always the case.

The only time to be concerned during a stock market crash is if the financial impact has a significant impact upon the future prospects of the business.

For example, with COVID-19, the airline business changed significantly due to travel restrictions, which ultimately had the impact of putting some airlines out of business.

At the same time, companies like Amazon thrived because people were forced to spend more time at home, where they would only really be able to buy things online.

With that in mind, keeping an eye upon how a financial crash impacts upon consumer behaviour is key.

How long should I hold a stock for?

The longer you hold a stock for, the more likely you are to be successful with an investment. This is because you are giving time for the company to grow, which will ultimately benefit your return.

Short term trading strategies have become popular due to people’s desires to get rich quick, but research has shown that having a long term approach is the most profitable.

Research carried out by JP Morgan, the American investment bank, found that the stock market moves significantly only 18 times in a decade.

They found that if you did not hold stock on those 18 trading days, that your returns were significantly reduced.

The issue for most traders is that it is incredibly hard to predict when those 18 days are going to be as they can sometimes be totally illogical. For that reason, long term investing is the optimal way to invest.

As for how long you should hold stocks for, it depends upon their development stage.

If you hold stock in a company that continues to grow and grow, then you ought to keep it for as long as possible. On the other hand, if you invest in a company that starts to slow down, it’s best to think about selling it – hopefully at that stage you are in a very profitable position.

As always, it’s important to keep an eye on consumer behaviours to see if any changes will harm your business. You want to invest in companies that remain competitive over time, avoiding complacency.

It’s difficult to give a specific timeframe as companies have different life spans. One company may be classed as a growth company for several decades, while other companies may complete their life cycle within 5 years.

In the finance industry though, long term investments are investments that are held for 7 to 10 years (or more).

How often should I look at my portfolio?

Unless you are unemployed, portfolio management will be very passive. Individuals don’t typically have the time to manage a portfolio on a day to day basis like a professional investor would.

Looking too much at your portfolio can be very harmful for your performance anyway as investors tend to suffer with human errors.

There is a tendency in investment to over-trade stocks because they are very liquid assets (meaning that it is very easy to buy and sell stocks).

It’s really easy to convince yourself that you have come up with new investment ideas that are better than your original ideas, after you’ve made your investments.

A lot of these psychological tendencies are going to harm your investment returns by not giving enough time for investments to develop and through increased transaction costs.

Having an annual review is the best practice for your portfolio as it gives you a chance to assess the returns that you’ve made in the last year.

Aside from an annual review, it’s only necessary to look at your portfolio if something significant has happened in the market. At these moments, you may need to make changes to protect your positions.

Most of the time though, on a normal day to day basis, it’s not helpful to look at your portfolio too much. If you take a long term perspective, there’s no need to worry too much about short term issues (unless they fundamentally change the underlying business).