Don't Invest in Individual Stocks!Last Updated: November 17, 2018
A lot of people are drawn to the stock market for the same reason people are drawn to the lottery: the chance of winning huge on relatively small investments. The problem is, even people smart enough to recognize lotteries are completely chance based can still fool themselves into thinking the stock market isn't. The illusion of skill in choosing individual stocks is very well constructed and powerful, but it's still an illusion: investing in individual stocks is more of a gamble than playing poker.
Every Investment is a Bet Against Someone Who Got to Set the Price
In the Texas Hold Em style of poker, there are two types of cards: the ones people hold in their hands and only they can see, and the cards on the table that everyone can see. When you're playing poker, you at least have an idea of why you're betting what you do. You have certain cards, and the opponents have certain cards, and you think your cards match the cards on the table better than theirs, so you place a bet that's higher or lower depending on how confident you are that your cards are better. But there's a chance you underestimated their hand, and lose the money you bet.
Well in the stock market, it's even worse than that. The cards are information, and unless you spend dozens of hours every week studying the different markets and businesses, you have no idea what your cards are. So when you see a stock that's being sold for, say, 20 dollars, you might think that's a decent deal, but the part you're forgetting is that that's not a price tag. It's a bet. You're looking at a bet someone else placed after examining their own cards, because they often have more information on it than you do. They wouldn't be selling it for that if there's good reason to think it's worth more.
If you were playing poker, you'd never bet on a hand without even looking at it first. But that's what you do every time you invest in individual stocks.
But wait, it's even worse than that!
Every Investment is a Bet With Others Who Have More Info Than You
Let's say that guy also didn't do his homework, so his cards are hidden from him too, and he just priced it arbitrarily. Then there's a chance he undervalued it, right?
Unfortunately, just like most poker isn't played one on one, the stock market isn't either. There are people who spend their entire work day studying stocks and looking for good deals. Undervalued stocks get snatched up in, quite literally, seconds, by people who use computers to analyze more information in a minute than you could understand in a day of careful examination.
So it's not just you and the seller at the table, judging if his 20 dollar bet on the stock is worth it: there are thousands of other people looking at the same exactly bet and deciding if it's worth it, and they see far more cards: enough to decide with much better accuracy than you possibly could whether it's actually a good deal or not, and bid higher (buy it) if it is.
What's left is the element of pure chance. In Texas Hold Em, the cards on the table come out in waves: first three called the flop, then a fourth card called the turn, then a last fifth called the river. There's always a chance that the last card utterly changes the game, but again, that chance is calculated by people who spend hours every day calculating it. Even if you do some research, what you are ultimately betting your money on is the chance that:
- The person selling the stock has less information than you.
- All of the other people looking at the stock and passing up on it have less information than you.
- The river card (chance) is in your favor.
And that last bit is where the anecdotal stories of people who bet a few hundred dollars and made a thousand times their money back come from. What's important to remember is that these are anecdotes, just out of the millions of people who buy lottery tickets, there will eventually be some winners. If they continue to play and bet more, however, they will slowly but surely lose all their winnings back.
So What's Left?
If you still want to get into investment, there other options besides throwing darts at the wall, such as broad market indexes, no-load broad bond indexes, or a Vanguard broad stock index. We'll go over those in more detail in the future, but the key to all of them is diversified investments that pay off over the long term. The thing to remember is that there are no reliable and quick ways to get rich on the stock market, or everyone would be doing it.