Methodology

Stocks

Module 1

Stock Market Expectations

When it comes to making investments, people tend to get very excited about how much money they are going to make. People usually think that they will be able to grow their savings into millions, in only a matter of months.
The reason that people have that perception is typically because of the investment banking industry. In TV shows or in movies, it is often the case that an investment banker is shown driving a Ferrari, blowing money in the casino and dining in high-end restaurants.

The thing that the TV shows or movies miss out though is that the banker would have made a bonus of say $500,000, after being responsible for a $500m portfolio, generating $50m in capital gains.

So, for an ordinary person, that image is impossible to achieve, unless they have millions to invest already. Therefore, it is important to be realistic with expectations, as it is easy to become frustrated with the performance of your portfolio – which can lead to bad decisions being made.

What is considered to be a good return?

As a standard, a good return on the market is seen as a return of around 10% a year. So, if you invest $10,000, for instance, you should expect to achieve a return of around $1000 in a single year.
The reason that 10% has been identified as a usual return in the stock market is that it is the same return as the whole market. This essentially means that if you added all of the stocks in a stock market together, their joint performance would be around 10% a year.

Many investors try to outperform the market by achieving a return that is much greater than 10% a year. A lot professional investor will achieve that goal, earning returns as high as 40% a year.

Although 40% a year is outstanding, it is incredibly hard to maintain consistently over time. This is because the stock market is unpredictable at times.

 

Nonetheless, if an investor is able to outperform the rest of the market (i.e. achieve a return that is higher than 10% a year), then it is considered to be excellent. In the world of investing, this is known more technically as ‘achieving alpha’.

The compound effect

For the majority of investors, the thing that helps them to get rich is the compound effect. The compound effect occurs when you earn a return on money that you originally invested as well as on the money that you have previously made with an investment.

To illustrate this, if an individual invests $100 in a stock that earns 10% a year, they would have $110 at the end of year 1. Then, for year 2, the investor would earn 10% on $110, meaning that they would end the year with $121, having earned a return on their original investment and previous return. This is what the compound effect is.
Over the long term, the compound effect can help an investor to make a lot of money from their investments.

For example, if an individual invests $10,000 into a stock that earns 10% a year, after 10 years, their investment would be worth around $26,000.

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