4 Major Stock Market Myths

Like many aspects of society, Wall Street has bred its own mythology. Some of these myths about the stock market are quite harmless, but some can have deep financial consequences for those who subscribe to them.

One of the biggest myths of the stock market is that what goes down, must go back up (and its corollary, what goes up, must come down)….

Considering that the markets fluctuate on a daily basis, it’s not at all difficult to see how this myth originated. But in reality, the laws of physics do not apply to the stock market, and there’s a reason that the saying “those who try to catch a falling knife will only get hurt” developed. There also exist many examples of rising stock prices which continued to rise and investors, if they subscribed to this myth, would have lost out on potential gains.

The myth that investing in the markets is like gambling is another myth with easy-to-spot origins. It’s simply a fact that people make and lose money in the markets every day, and sometimes it’s a lot of money. Some industry professionals further this myth with language about “betting.” But the truth of the matter is that informed investing is fundamentally very different from gambling. Gambling is a zero-sum game; money is transferred directly from one party to another while creating no additional value. Investing helps to create value in the markets that never existed before. Not to mention, investing smartly has a positive expected value.

A third major myth about the stock markets is that a typical rate of return on stocks is 10% yearly. This has a little more complicated origin, since the numbers come from the 1800s. It turns out that that 3 of those 10 percentage points came from inflation, and the rest of the data is still suspect. The fact of the matter is that you generally can expect a 7-8% average return, assuming that you purchase stocks at average valuations.

A fourth myth about the stock market is that you must necessarily assume high risk in order to make money. Once again, it’s easy to see where this myth came from since investments with particularly high risk typically provide a higher reward in order to offset said risk. However, this myth is simply mathematically untrue. Investors with a smaller amount of money invested make money every day. Investors with smaller amounts of money can save on expensive brokerage fees and costs by engaging in do-it-yourself investing, which is growing in popularity as investors seek to become more involved with their portfolio after the recent economic crisis.