how to conquer your fear of the stock market

Introduction

How do you conquer the fear of the stock market? A lot of people are fearful of investing in the stock market. In fact, everyone has a form of apprehension about losing money. And why not?. Even if you were optimistic about investing, there is the “capital at risk!” caveat always present on every investment platform. Also, like me, you may have lost money investing in the stock market in the past. There are many reasons people have a fear of losing money in the stock market. However, I believe you can start conquering that fear by understanding what stock market investing is not.

Investing in the stock market is not…

A get rich quick scheme

To conquer your fear of the stock market, understand that investing is not a get rich quick scheme. My dad told us a story about a time his mum sent him to buy some groceries. Along the way, he was attracted to a crowd gathered watching a magician/money doubler. Money doubling magic acts was common in those days. To cut the story short, he was robbed and all the grocery money stolen. Guess who got in trouble that day?

In the same vein, be wary of grandiose promises of instant stock market returns. The aim might be to distract you while picking your pocket. The stock market is not the place to double your money in an instant. You could try your luck at a casino instead. While doubling your money from making stock market investments is possible, it doesn’t happen overnight. Any investments likely to double quickly will also carry a huge amount of risk.

Trading/Speculating

Investing is different from trading/speculating. See the following definition of investing:

An investment operation is one which, upon thorough analysis promises safety of capital and an adequate return. Operations not meeting those requirements are speculative.

Benjamin Graham, The Intelligent Investor

Note the ‘thorough analysis‘ in the definition. Every investment needs to be accompanied by a business case to justify that investment. Speculation is simply deciding to invest your capital without sound analysis. An example of speculating is investing because someone said it was a good idea, without doing your own investigation or understanding the rationale.

There is something called intelligent and sophisticated speculating/trading. A lot of people make money trading, but it takes a special skill set and a huge appetite for risk. It is important to clearly differentiate between investing and speculating. This is because trading requires a different approach and skill.

Understanding what investing is will enable you to get the skills required for confident investing and will help you conquer the fear of the stock market. Assuming that you are investing when in fact you are speculating and vice versa is one of the major pitfalls of investing. In the first instance, you might be buying and holding an investment you are speculating on and taking a passive stance when you should be active.

Risk-free

Investing in the stock market is not risk-free. Different assets have varying degrees of risks. Some will argue that risk-free assets like treasury bills are not entirely free of risk. There is always a possibility of unknown factors affecting the safety of your capital. Managing this expectation will prepare you to understand and expect the volatility of stock market prices. Furthermore, it will help you prepare and learn how to manage investment risk effectively. Overall, accepting that investing is not risk-free and a good understanding of risk will help in recognising the trade-off between risk and return. Accepting risk will also mean that you can engage strategies from the onset to manage risk.

Having understood what investment is not, what is investing?

Going back to the definition above, it is making an informed decision to invest in a venture with the hope of securing a return on your investment. So to conquer the fear of the stock market you have to become a confident investor. How do you make informed decisions when investing? Read my post on 7 things you need to do before investing, then consider the following 4 points to get started.

Pay attention to the following to conquer your fear of investing in the stock market

Investor profile

Your investor profile tells you what kind of investor you are. Also, your lifecycle stage will affect how you make decisions and determine your risk profile. For example, a young person in their 20’s will have a longer investment horizon and will be able to take more risks. A middle-aged person close to the peak of their career should be able to accept moderate risk. A retiree is in their spending phase and will need to rely on income-generating assets to fund retirement. There are different risk profiles and investment products suited to individuals at different stages of their life cycle. Identify the phase you are in life and determine the measure of risk you are comfortable with. Then choose an investment strategy that fits your investment profile and goals.

How Knowledgeable are you?

It is important to have a good understanding of the stock market. This still applies if you choose to outsource the management of your investment to a professional. Learn how to read the reports you’ve been sent and what to look out for in those reports. Investments can seem complicated even for finance professionals. But you can start always start building your investment knowledge one step at a time.

If your understanding of stock market investing is limited, start by investing in the things you fully understand. And if you choose to speculate on assets you don’t fully understand, keep your exposure low by committing funds you can afford to lose. Then gradually increase your activity as your knowledge grows.

Diversification

We’ve all heard the expression “don’t put all your eggs in one basket”. The act of not putting your money in one basket in investing is called diversification. This is one of the sure ways of reducing risks in stock market investing. For instance, if you invest in one company stock, this carries a specific risk (unsystematic risk) associated with it. However, if you invest in several companies that are different or behave differently from each other (negative correlation) then you can reduce the risk specific to each company.

Suppose you buy shares in a company that produces ice cream and another company that produces raincoats. If we have predominantly wet weather for most of the year, the shares in the ice cream company may fall due to a fall in sales. However, the raincoat company will likely have higher sales because people will need raincoats resulting in a boost in its price. That way, the net effect on your portfolio will not be as bad as if you had all your investment in the ice cream company. You can diversify your portfolio by choosing stocks with negative correlation or by including different asset types e.g.bonds and stocks. Most beginner investors will not have the level of funds, time, or skill to build a well-diversified portfolio. The easiest way to achieve a diversified portfolio is by purchasing mutual funds.

Passive versus active

A passive investment strategy refers to buying and holding assets. An active investment strategy involves engaging in active buying, selling, and monitoring of your investments. For example, a mutual fund that follows a passive strategy will simply replicate a role model stock market index of its choice e.g. the FTSE 100.

My masters’ degree dissertation involved comparing passive mutual funds to active mutual funds. I researched to find out whether active funds deliver superior returns to index funds. My findings were similar to other studies and concluded that the passive funds in my sample performed similar to or better than active funds. One reason for this is due to the costs involved in buying, selling (brokerage fees, and so on), and management of active funds. Even though I invest in both active and passive funds, I only invest in active mutual funds with a good performance record and low fees. In a nutshell, if you are actively investing, either by your self or through a fund, pay attention to the costs.

Conclusion/Key takeaways

In conclusion, to conquer the fear of the stock market;

• Be clear on what investing is not
• Understand what investing is
• Understand your investor profile to determine your risk appetite and investing strategy
• Make use of diversification to reduce risk
• Decide on whether you want to invest using a passive or active strategy.

I hope all of the above will help you conquer any fear of investing in the stock market and help you on your investing journey. If you have any questions, drop me an email. Leave a comment and please share! I will be covering more investing topics in the coming weeks so stay tuned. Have a valuable week!