The very basic essence of stocks is that you buy a “share” of a company in order to own a portion of the company and “share” in it’s successes. If the company decides to not reinvest it’s profit into itself and instead pay a portion, or all, of that profit to the owners, you get a bit of it in the form of a dividend. It the company does reinvest the profits into itself, it increases the value of the company, and your “share” of the company increases in value as well. You can then sell your “share” of the company to realize that increase.
But, that’s only at it’s most basic level. Today, the world of stock investing is so much more. There are options, short selling, margin trading, ETFs, mutual funds, hedge funds, and a myriad other ways that you can partake in this sometimes exciting, and always risky world. It isn’t just simply owning a portion of a company anymore. You can sell shares of companies that you never owned in the first place. You can buy on margin with money you never had. And you can do it all whenever you want.
But, has this evolution of the stock market become a cancer on the world? So much of our economy relies on the stock market as an indicator of the world economic health. If stocks drop, so too does much of the rest of the economy. And if a company does poorly, and many of it’s shareholders sell, causing the price to drop, it can have a ripple effect on the rest of the industries companies, or even on the stock market as a whole. In May of 2010, just such a sell off caused a drop in the stock market that had the entire world trembling in fear of a worldwide economic collapse. It was caused by a trigger in an computer algorithm that was mistakenly set wrong. Many of the stock markets closed early to try (unscheduled rather than one of the normal stock market holidays) and curb the crash and hold off a more drastic drop.
The way the stock market works has evolved so much in order to optimize the buying and selling of shares of companies merely for the profit of the brokers and day-traders. Very few investors will buy a share with the intention of holding it for more than 5 or 10 years. That’s a drop in the bucket for companies that have been around for over 100 years.
Events like the crash of May 2010 and the crash in 2008/2009 due to the real estate bubble bursting give us all pause when we think about investing. For those of us who don’t want to try and “beat” the market and who proscribe to a more long term approach to investing, the drastic ups and downs of the market are cause for concern. What happens if the crash can’t be stopped?
Is it fixable?
Perhaps, but I don’t think that the many brokers and traders who make their money with the newer methods of investing will allow it to happen. To truly fix the market, it needs to revert to it’s much more simple state. Simple buying and selling of shares. No options, no shorting, no margin. Just ownership of a company. After all, that’s what it’s really about. And if it can’t be fixed (or won’t be allowed to be fixed), perhaps it’s time the investors who don’t like the way it’s working move our money someplace else. There are plenty of opportunities in your local communities to invest in start up companies and other investment vehicles.
A word of warning though. Those local opportunities are generally much more risky than buying a share or two of a company like Proctor and Gamble who have been around for decades. Only about 10% of start-ups still exist 5 years later.
Risky as it is, the stock market can still be a sound place to keep your money. Yes, you do run the risk of losing your investment. Nothing there is insured or guaranteed like you would see if you had your money in a savings account at a NCUA insured Credit Union or a FDIC insured Bank.
Has stock trading ruined the world? Not yet. Will it? Let’s hope not.
Image Credit: Bear Market by AZRainman, on Flickr
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Dr Dean says
What a coincidence, having published a stock buying post today!
I think, in this zero interest rate environment, that basic stock picking will come back. With people looking for earnings power, low debt, and dividend paying companies.
Who can get the yield they need in the bond market. I think it will just take a little time for folks to get their confidence back. I will go on record that we will have double digit gains next year!
Invest It Wisely says
The stock market has indeed become highly complex. The impact of HFT (high frequency trading) programs is something that we need to be on the alert for, to ensure that they are performing a legitimate service and that they are not swindling investors.
I don’t agree that we need to ban shorting and other valid investing methods. The short is a perfectly valid investment method, but I do agree that it can be abused via means such as the “naked short sell”.
I don’t think going backwards is an option, but as investors we do need to be vigilant, and ensure that the stock market functions as a tool to efficiently allocate capital, not to merely enrich some people at the expense of others.
While I agree that there should be a disconnect between the Dow index for the day and the economy as a whole, but more people are invested in the market then ever before so when that index drops and they see their 401(k) go down…then people panic and stop buying.
As to your other point, I don’t think stock trading has ruined anything, because people always “traded.” There is no such thing as the good old days.