I visualize investing as a stream of water. Imagine this stream meanders from left to right. The left to right movement is indicative of prices going up. Now imagine this stream is always going from left to right. It consistently moves at a slow pace. This movement represents the style of investing that everybody would like. Now imagine it increases by about eight to 10% per year. That would be a great way to earn your money. Of course, you would like to have even a higher rate, but 8% to 10% is more than enough for anyone to earn a great living.
You can earn a lot more than you ever made at your job as long as you can save around 30% to 50% of your earnings and invest those earnings into the stock market. The unfortunate thing is the stock market is not really like this. As you can attest, the prices go way up and way down. It’s not like a steady slow stream. If we compare the real stock market to the stock market that we are describing. When you look at the real stock market you can see the prices go way up faster than five to 10% and way faster, in the wrong direction, as well. Sometimes they can swing in the wrong direction so the prices go down. Therefore it’s not a constant increase, but it’s an erratic thing. The reality is, both forms are correct. And both exist at the same time.
Now imagine two streams. One steam slow and steady. Going to the right, always increasing prices, and then imagine the next stream. Going back up and back in any direction fast. Those two streams are very different now if you put your money on the slow and steady stream you’re going to get a constant increase. If you put it on the right stream you might get periods where you’re gaining faster but you’re also going to get periods where you’re losing.
The reality is, the stock market is one stream, where both of those streams are currents. And so when you add a slow current with a fast current the faster current plays the major rule. But here’s an important thing to understand the fast current always, over a long period, does not change direction. So it might swing to the right, very fast, and then it will swing to the left equally fast. This is what you have to understand, that over a long period we’re talking over 20 years. The fast current has a net effect of zero. What happens is you get the effect of the slow stream. This is why if you invest properly. It means investing in the long term. You can earn a lot of money with this.
This is the idea of a fast current versus a slow current. But the thing is if you imagine the two currents and let’s say one is two kilometers per hour and it’s consistent for life, but the other current is sometimes 10 or 20 kilometers an hour to the right, and sometimes it’s to the left. But it’s always going in either direction. So, the net effect of the fast current is zero over a long period, although in a short period, you might be swinging ahead, really quickly, as compared to the slow current. Equally, you could be swinging backward compared to the slow current.
When you invest over a short period. The small currents are taking a major effect on you. And if you invest over a long period, your focus is going to be on the slow current because the fast current will equal zero, over time, you can imagine the fast current as a pendulum. It swings fast to the right and then it swings fast to the left. While it is always moving, the net effect is no movement. The net effect of the fast current is zero. This is why trading in the short run, is a zero-sum game. What that means is that some people lose, and some people win. It’s a very risky endeavor. For every winner, you have to have one loser. And that’s important to understand.
But if you go for the long term, everyone can be a winner because what you’re doing is you’re going with the flow of the economy. That’s how the stock prices rise economies good companies make money, companies make a profit. Dividends are paid stock prices go out. That’s the long run, the short-run, runs on fear, and greed, it’s running on emotions. There’s a famous saying by Benjamin Graham which goes, “In the short run the stock market is a voting booth. And in the long run, it’s a scale.” What he’s saying is similar to what I’m saying is that in the long run, you have the slow current, and that’s your true scale. In the short run, you have erratic emotions, which is your voting booth. And that’s very chaotic. This is your fast current, the zero-sum game. You can win, as well, in the short run, but you have to know what you’re doing and that’s for a whole other book. For the beginner, if anyone tells you, then you can win in the short run, be very wary about that because you will need to learn a lot to understand all the mechanics of investing, all the ways to protect yourself. The reality is, short-run investors rarely do, as well as long-term investors because you’re playing a zero-sum game, you’re going to win some, and you’re going to lose some. Overall, if you win, $10, it means somebody somewhere has lost $10. As well, you are paying fees with every transaction. There are two types of fees, your actual broker fees and then the spread fees. If a stock is worth $10.25, you will likely pick it up at $10.27 or higher, this is an embedded cost that you are not even aware of. This occurs for both your sales and your buys. With long term investing, this is far less of an issue than with short term investing. Whereas, if you invest in the long run. Everyone wins. The whole stock market wins. So you don’t have to.
Remember to always seek the advice of an investor or a trusted friend that does invest before you start to invest. There are many ways to earn money but also many ways to lose. If you want to follow a low-risk approach, then invest in a good ETF or index fund for the long term, at least 20 years, and also look to invest consistently, do not invest all at once. Always be patient and never let emotions get the better of you!
To find out more about investing – download this free book today!
Get it here!
