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Investing in Stock Market: Ignore Additional Challenges

Don't Believe "It's Different this Time"

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Investing in the stock market has never been more challenging or easier. Thanks to technology, you can buy and sell stocks without ever talking to another human.

And stocks and bonds, the most basic building blocks of the market, are only the beginning. A wide variety of other financial instruments are also available to many individual investors, ranging from the option, which has been around forever, to sophisticated derivatives that few truly understand.

Institutional investors also have a huge range of financial products to consider, some so risky even the companies that created the products are afraid to hold them - as witnessed in the financial crisis of 2008-10.

Many of these financial products provide needed services to the market, such as liquidity, risk transference and others. However, a number of the products also fail this basic test and fall into the category of pointless speculation.

The companies that create, market and sell these products would argue otherwise and produce a long list of benefits to the market and investors. Maybe they are right and maybe they are simply engaged in selling product regardless of its efficacy.

Institutional investors (investment banks, pension funds, insurance companies and so on) typically have large staffs of analysts, researchers and other financial professionals to sort through the details of potential investments.

Yet, for all their collective intelligence, many institutional investors ended up with junk in their portfolios when the markets collapsed.

The point is individual investors seldom have anywhere close to the same resources and yet, financial companies marketed some of these sophisticated products to people who didn't have a complete understanding of what they were buying and accepted on face value the risk assessment, which was usually much lower than it should have been.

"It's different this time," is a phrase heard all too often in the stock market.

You may hear it associated with a bull or bear market. You could hear it used to describe the new darling stock of Wall Street or a new investment strategy or product guaranteed never to fail.

Whenever you hear it, you would be wise to ignore it.

The phrase is almost always used to describe a phenomenon that defies conventional investing or market wisdom.

Stock Boom

Remember how the tech boom of the late 1990s was "different this time?"

Earnings didn't matter. Balance sheets didn't matter. Sometimes even products didn't matter. This was the new age - the new economy.

In truth, many things have changed thanks to technological advances.

However, they changed because real companies produced real products and services and found a way to make money doing it.

The hundreds of companies the flamed out when the dot.com boom went bust may have had great ideas, but they were unable to translate those ideas into viable businesses.

Stock Ideas

The lesson for all of us is that assuming a good idea will become a good business is a mistake.

It is also a mistake to assume that there are many new situations facing the market.

It is easy to get caught up in daily headlines and assume the stock market is facing a new and unprecedented crisis.

In most cases, this is not true. Credit crunches, liquidity problems, crashes in particular stock sectors and other major problems have all rolled through the market before.

This is not to say the market won't react badly to severe problems. However, experienced investors know there is usually an end to any crisis and the market will be back on track. That may not be the case with more sophisticated financial products.

Stock Challenges

There are new challenges for investors and the stock market, but it is unlikely that any, barring an extreme external event, will permanently change the basic principals of how the market works.

Companies still need to earn profits to stay in business. Businesses that are better at earning profits and have greater future potential will command a higher price in the market.

Stocks represent a legitimate ownership in companies and bonds a legitimate debt owed by the issuer. It is possible for individual investors to understand what the company does and the risk associated with owning debt.

Likewise, before individual investors consider sophisticated financial derivatives, it is important to know what role they play in the market and what is the true risk involved.

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