How many really understand how investing works?

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rocko
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How many really understand how investing works?

Post by rocko »

I don't.

It scares me to know that I don't really understand how the stock and bond markets work.

Sure, I get the basic, surface stuff (diversification, AA, risk/rewards, etc) but I am no expert and yet I have been willing to place much of my life savings in this system... partially because of the heard mentality (my friends and parents invest) and partially because I've been rewarded with reasonable results (approx 5% annual gains over the last 10 years) and partially because I don't want to add to my real estate assets by going from homeowner to property manager).

I am trying to gain a better understanding of investing but can't shake the feeling that the financial system is "gamed". Especially after seeing the market behave in ways I can't logic or losing a great deal of money through terrible advice by a stock broker at a "respected" firm. That is why I moved everything to Vanguard 15 years ago and self-manage.

The bottom line - I have become very, very cautious with my IRA money. I must make sure I don't make any stupid mistakes in setting up a portfolio I can live with - be it three fund or CDs with an equity component. Thankfully, I discovered this site!

Am I alone?
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Taylor Larimore
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Re: How many really understand how investing works?

Post by Taylor Larimore »

Rocko:

This Investopedia tutorial may be helpful:

Investing 101: What Is Investing?

Conclusion: "For the average investor, the smart route includes saving regularly, keeping investment expenses down and being in the market for the long term."

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
Stan Dup
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Re: How many really understand how investing works?

Post by Stan Dup »

You are not alone. Many people here probably have the same feelings you do on occasion.

Your questions can well be applied to life in general, not just the stock market.

It is all about risk management.
"The tyranny of compounding expenses is the eighth deadly sin." - George Sisti
Grt2bOutdoors
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Re: How many really understand how investing works?

Post by Grt2bOutdoors »

If you haven't yet, read Warren Buffet's annual shareholder letters - they are all there on www.berkshirehathaway.com. If you can understand that, you can understand investing in layman's terms.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
Gropes & Ray
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Re: How many really understand how investing works?

Post by Gropes & Ray »

I wouldn't say I have a great understanding of investing. I certainly know how corporations work, and I understand the legal implications of owning stocks or bonds. I also understand selling products or services in exchange for money. But when it comes to things like calls, puts, short-selling, blah blah blah, I don't understand it. I don't understand commodities. Basically, I look at investing as owning a small piece of a business that is more likely than not going to make money. That's good enough for me, and it makes me satisfied with index investing.
Last edited by Gropes & Ray on Wed Mar 11, 2015 8:11 am, edited 1 time in total.
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Re: How many really understand how investing works?

Post by Grt2bOutdoors »

Gropes & Ray wrote:I wouldn't say I have a great understanding of investing. I certainly know how corporations work, and I understand the legal implications of owning stocks or bonds. I also understand selling products or services in exchange for money. But when it comes to things like calls, puts, short-selling, blah blah blah, I don't understand it. I don't understand commodities. Basically, I look at investing as owning a small piece of a business that is more likely than not to make money. That's good enough for me, and it makes me satisfied with index investing.
Making money is good, retaining the money in the business and growing it is good, increasing stockholders equity and thereby your value per share is good. Now, what's not so good - making money, rewarding management and not sharing it with the shareholders - there are companies out there that do exercise such poor choices, eventually those companies are rewarded by lower stock prices, fired management, loss of customers and business, etc.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
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SteelyEyed
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Re: How many really understand how investing works?

Post by SteelyEyed »

It's easy:
  • Step 1 - Invest
    Step 2 -
    Step 3 - Profit!
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Re: How many really understand how investing works?

Post by ponyboy »

SteelyEyed wrote:It's easy:
  • Step 1 - Invest
    Step 2 -
    Step 3 - Profit!
Thats esentially how the underpants gnomes did it in southpark.
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Re: How many really understand how investing works?

Post by pkcrafter »

Here's a good start:

Defining our goal
Investing: Money committed or property acquired for future income. A trade off between risk and reward while aiming for incremental gain and preservation of the invested amount (principal). Investing means investing in businesses, both in the U.S. and internationally. It is, by definition, a long term commitment to share in the successes of companies in businesses for profit.
Speculation: Aims at high gain or heavy loss.
Gambling: Betting (wagering) that must result either in a gain or a loss. Gambling is neither risk taking in the sense of speculation (assumption of substantial short term risk) nor investing (acquiring property or assets for the securing long-term capital gains.

You can take the investing definition a bit further this way: It's putting faith into the capitalistic system itself. If you believe the market is gamed, and I'm sure to a certain degree it is, then as an outsider to the game, the only smart way to invest is to buy into the total market and not attempt to beat those with inside information because you don't have a chance of doing it. Buy, hold, compound, rebalance.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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rocko
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Re: How many really understand how investing works?

Post by rocko »

^ SMART!

Taylor: Thank you so much for the link.

And for those of you willing to share... how do my overall returns of 5.6% (ten years)/7.5% (five years) compare to yours?
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Re: How many really understand how investing works?

Post by Grt2bOutdoors »

rocko wrote:^ SMART!

Taylor: Thank you so much for the link.

And for those of you willing to share... how do my overall returns of 5.6% (ten years)/7.5% (five years) compare to yours?
Would you compare the performance of a Toyota Corolla to a Mercedes S-Class? Then why are you trying to play the comparison game up above? If your willing to share your returns, then please share the composition of your portfolio for each of the years those returns represent. Otherwise, you are just comparing apples to oranges.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
red5
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Re: How many really understand how investing works?

Post by red5 »

rocko wrote:^ SMART!

Taylor: Thank you so much for the link.

And for those of you willing to share... how do my overall returns of 5.6% (ten years)/7.5% (five years) compare to yours?
I'll share with the knowledge it is comparing apples and oranges (or perhaps it is red delicious and granny smith)...

7.5% ten year return and 11% five year return - Calculated using XIRR to find my compound growth rate in Excel. I've had a pretty aggressive stock/bond allocation, anywhere between 80% and 100% stocks.
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rocko
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Re: How many really understand how investing works?

Post by rocko »

^ Wow
an_asker
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Re: How many really understand how investing works?

Post by an_asker »

rocko wrote:I don't.

It scares me to know that I don't really understand how the stock and bond markets work.

Sure, I get the basic, surface stuff (diversification, AA, risk/rewards, etc) but I am no expert and yet I have been willing to place much of my life savings in this system... partially because of the heard mentality (my friends and parents invest) and partially because I've been rewarded with reasonable results (approx 5% annual gains over the last 10 years) and partially because I don't want to add to my real estate assets by going from homeowner to property manager).

I am trying to gain a better understanding of investing but can't shake the feeling that the financial system is "gamed". Especially after seeing the market behave in ways I can't logic or losing a great deal of money through terrible advice by a stock broker at a "respected" firm. That is why I moved everything to Vanguard 15 years ago and self-manage.

The bottom line - I have become very, very cautious with my IRA money. I must make sure I don't make any stupid mistakes in setting up a portfolio I can live with - be it three fund or CDs with an equity component. Thankfully, I discovered this site!

Am I alone?
Quick point first. It is the 'herd' as in 'herd of cattle' mentality that folks refer to, not the 'heard' as in 'hearsay' mentality!

With that out of the way, many (most?) Bogleheads will likely say that the 'herd mentality' is not the right one to adopt in the stock market. If you follow everyone else like cattle (or lemmings), you would fall off the cliff. Ideally, you want to go the other direction (though that would count as market timing hereabouts). So, the real answer is, stay the course (one can always keep a small amount of fun money to see if the excitement will pay off or ... wear off :oops: )!

Either way, you appear to be doing just about average ... as you should!
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rocko
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Re: How many really understand how investing works?

Post by rocko »

Of course comparing returns are apples to oranges. That's the point!

I already know what my strategy is producing. I want to know how the orange, tomato, grape, and carrot vendors are faring.
Last edited by rocko on Tue Mar 10, 2015 12:36 pm, edited 2 times in total.
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rocko
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Re: How many really understand how investing works?

Post by rocko »

an_asker: Actually, I've been following cattle and hearsay during my investing journey :)
red5
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Re: How many really understand how investing works?

Post by red5 »

rocko wrote:^ Wow
Don't let it wow you too much, I'm trailing the Vanguard 2045 retirement fund when taking into account purchase sums and dates :happy
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Re: How many really understand how investing works?

Post by an_asker »

rocko wrote:an_asker: Actually, I've been following cattle and hearsay during my investing journey :)
To a true boglehead, that is heresy! ;-)
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Re: How many really understand how investing works?

Post by bberris »

You can buy an airplane ticket without knowing how an airplane flies.
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Re: How many really understand how investing works?

Post by GoldenFinch »

I put my money in this collective piggy bank called "the market" and never take it out.

When the market is going up, like these lovely recent years, I can watch it grow to a hefty sum and feel alright about the world and my family's future.

When the market tanks for many years, as I have seen on a horrible occasion or two, I still put the money in, but completely ignore it and feel alright about the world and my family's future.

This simplistic, albeit juvenile, understanding of investing seems to be working out okay for me so far. :happy
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Re: How many really understand how investing works?

Post by lack_ey »

If I'm interpreting the question, it's not about how to invest or how companies work but rather how the markets work and where returns come from? Clearly I'm not qualified to respond, but I will anyway.

The stock and bond markets are just secondary markets where money is exchanged for existing financial assets. Investing is about buying, exchanging, and selling these assets. Buying in is a means of depositing money for later usage. When you put money in a bank, you expect to be able to withdraw it at a later date. In the meantime, the bank turns around, makes some money with your money, and pays you some interest. Same for putting it in stocks and bonds, except here there's no FDIC and there's the understanding that the dollar value of the deposit is not guaranteed when you want the money back out; there will be fluctuations in what buyers are willing to pay for your securities later. The stocks and bonds pay you some dividends in the meantime too. Market participants are human beings (and maybe algorithms written by people) and may or may not be rational and have the same aims as you. You might say that many of the participants are trying to game the system, but that is just a matter of perspective.

The terms of a bond are clearly stated in terms of cash flow and are legally binding. The coupon payments and amount paid at maturity are known to everyone. The prices on the market are influenced by market participant expectations about the risks involved and how much money could be made here as opposed to elsewhere, such as other bonds and maybe even stocks and other securities. Thus they depend on current interest rates, perceptions of default risk, expectations about inflation, and so on. The closer the bond is to maturity, the less uncertainty about returns and what else could happen in the meantime, so the closer the value in the market to whatever it is at maturity.

A stock comes with few guarantees and just represents a slice of ownership. Profits are distributed by some companies back as dividends. Companies are priced based on expectations of future earnings, assets, and growth, relative to all the kinds of risks including the company going bust. These are all kind of wishy washy. As such, the speculative component of stock pricing (over whatever the dividends, which are not even guaranteed, are worth) is large and capricious. Thus a change in expectations—say, from reports that profits might be huge rather than mondo huge—can swing stock prices significantly in an instant. Stock prices are propped up by the belief that others in the future will see the value of some future dividend stream from ownership (or book assets or something else) and maybe be able to pass it along again to somebody else at a favorable price. When that belief falters, say during a financial crisis, you see prices tumble. There's a whole lot more to it than this, though.
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Re: How many really understand how investing works?

Post by IPer »

rocko wrote: And for those of you willing to share... how do my overall returns of 5.6% (ten years)/7.5% (five years) compare to yours?
why? you think I am the one rigging the market today?!
Read the Wiki Wiki !
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Re: How many really understand how investing works?

Post by dbr »

Understanding is a question of degrees. Some people understand nothing (Well, maybe a lot if we include those fractions of the world population that have no involvement in investing as understood here -- but a poor farmer does understand the value of owning a cow.); a lot of people understand something but misunderstand more than they understand; some people understand enough to rationally accomplish their purposes in investing; a small number of people understand a great deal more than that; nobody understands the subject completely.
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rocko
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Re: How many really understand how investing works?

Post by rocko »

A side note:

The area in which I live contains many, many folks who live in multi-million dollar homes with all the trimmings. A significant number are hedge fund, capital venture, or equity capital guys (I say "guys" because I haven't encountered a single female in this category (sadly). Anyway, it's obvious that there are many super smart people in this world who know how to play the finance game... and I can't help thinking "I'm" the one (and millions like me) that they're making money off of!

Yet another layer to my investing paranoia.
Last edited by rocko on Tue Mar 10, 2015 2:04 pm, edited 2 times in total.
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Taylor Larimore
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Super smart people ?

Post by Taylor Larimore »

It's obvious that there are many super smart people in this world who know how to play the finance game.
It may appear "obvious," but it's not. It's been said that the easiest way to make a million dollars is to start with ten million dollars. Another way is to do what the casino owners do: Become the croupier instead of a customer.

This is a quote from The Bogleheads' Guide to Investing:
Mensa is an exclusive society whose membership is restricted to persons scoring in the top 2 percent on IQ tests. During a 15-year period when the S&P 500 had average annual returns of 15.3 percent, the Mensa Investment Club's performance averaged returns of only 2.5 percent.
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: How many really understand how investing works?

Post by lack_ey »

Taylor Larimore wrote:
It's obvious that there are many super smart people in this world who know how to play the finance game.
It may appear "obvious," but it's not. It's been said that the easiest way to make a million dollars is to start with ten million dollars.

This is a quote from The Bogleheads' Guide to Investing:
Mensa is an exclusive society whose membership is restricted to persons scoring in the top 2 percent on IQ tests. During a 15-year period when the S&P 500 had average annual returns of 15.3 percent, the Mensa Investment Club's performance averaged returns of only 2.5 percent.
Best wishes.
Taylor
It's been said and shown time and time again that some of the worst investors are the smart ones who are overconfident and don't know how to play the finance game. This example just demonstrates that there is alpha out there to be had by trading with these people (unless their stock exposure was low and that part earning what you might expect, and so on, or they were spectacularly unlucky). It doesn't disprove the potential existence of smart and not-so-smart people who do know how to play the game.

rocko wrote:A side note:

The area in which I live contains many, many folks who live in multi-million dollar homes with all the trimmings. A significant number are hedge fund, capital venture, or equity capital guys (I say "guys" because I haven't encountered a single female in this category (sadly). Anyway, it's obvious that there are many super smart people in this world who know how to play the finance game... and I can't help thinking "I'm" the one (and millions like me) that they're making money off of!

Yet another layer to my investing paranoia.
Note that the compensation structure of managers of hedge funds, venture capital, etc. means that one can become very wealthy without producing above-market returns or above-market risk-adjusted returns. It is also very possible that many or all of the apparently "successful" managers you see were only or mostly lucky for a certain period of time rather than skilled. The ones with the wrong combination of skill and luck you don't see or hear about.

If you invest in the entire stock market, you are not going to get ripped off in the aggregate unless the entire stock market is overpriced. It should be very difficult for a narrow amount of "smart" money (who are betting against each other and institutional players, anyway) to manipulate entire markets or exploit unique informational advantages by enough to move the needle significantly. I'm not saying that the markets aren't risky, just that this isn't the risk to worry about.
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Re: How many really understand how investing works?

Post by galeno »

I have an excellent understanding of investing. Took formal school about it. Have been doing it for almost 31 years and watched my father do it before.

That's why we use a simple, cheap, and diversified 2 ETF 60/40 portfolio.
KISS & STC.
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Re: How many really understand how investing works?

Post by FrugalInvestor »

rocko wrote:A side note:

The area in which I live contains many, many folks who live in multi-million dollar homes with all the trimmings. A significant number are hedge fund, capital venture, or equity capital guys (I say "guys" because I haven't encountered a single female in this category (sadly). Anyway, it's obvious that there are many super smart people in this world who know how to play the finance game... and I can't help thinking "I'm" the one (and millions like me) that they're making money off of!

Yet another layer to my investing paranoia.
Successfully playing the finance game in this respect doesn't necessarily require them to understand how investing works either, it just requires that they convince others that they understand it.
Have a plan, stay the course and simplify. Then ignore the noise!
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Re: How many really understand how investing works?

Post by Fallible »

rocko wrote: ...

It scares me to know that I don't really understand how the stock and bond markets work. ...
What you need to understand best is yourself and what is right for you and it can be the hardest part of investing. As the Investopedia "Investing 101" link that Taylor posted notes: "Investors can learn a lot from the famous Greek maxim inscribed on the Temple of Apollo's Oracle at Delphi: "Know Thyself". In the context of investing, the wise words of the oracle emphasize that success depends on ensuring that your investment strategy fits your personal characteristics."

If your investing strategy is based solidly on your personal life goals and your tolerance for risk, you stand the best chance to ignore the many alternative investing temptations and stay the course. That's how investing really works.
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
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Re: How many really understand how investing works?

Post by pkcrafter »

rocko wrote:Of course comparing returns are apples to oranges. That's the point!

I already know what my strategy is producing. I want to know how the orange, tomato, grape, and carrot vendors are faring.
No, you don't. Don't play that game. I checked your prior posts to see what's going on because asking this question is meaningless.
Anyway, it's obvious that there are many super smart people in this world who know how to play the finance game... and I can't help thinking "I'm" the one (and millions like me) that they're making money off of!
Nope, it's not you unless you are changing things, chasing performance, or making other behavioral errors.
And for those of you willing to share... how do my overall returns of 5.6% (ten years)/7.5% (five years) compare to yours?
It's a meaningless question because we don't know what your portfolio looks like. OK, I looked--you are 30% total market and 70% total bond. Since you are matching index returns, there is no reason to ask how others are doing. Others have different allocations and may have selective memory or don't calculate returns properly. You have to have some confidence in your own approach.

I also saw you are withdrawing between 3-4% of assets, which sounds fine. My only suggestion might be to consider TR income, which is 30/70, but has better diversification. Or maybe add Wellesley at 40% to what you have. If you keep what you now have, think about adding TIPS and moving to intermediate term bond index or adding short term corporate. I mention Wellesley because your 30% stock is on the edge of being enough. Diversifying bonds and reducing overall duration is also a good idea.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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nedsaid
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Re: How many really understand how investing works?

Post by nedsaid »

rocko wrote:I don't.

It scares me to know that I don't really understand how the stock and bond markets work.

Sure, I get the basic, surface stuff (diversification, AA, risk/rewards, etc) but I am no expert and yet I have been willing to place much of my life savings in this system... partially because of the heard mentality (my friends and parents invest) and partially because I've been rewarded with reasonable results (approx 5% annual gains over the last 10 years) and partially because I don't want to add to my real estate assets by going from homeowner to property manager).

I am trying to gain a better understanding of investing but can't shake the feeling that the financial system is "gamed". Especially after seeing the market behave in ways I can't logic or losing a great deal of money through terrible advice by a stock broker at a "respected" firm. That is why I moved everything to Vanguard 15 years ago and self-manage.

The bottom line - I have become very, very cautious with my IRA money. I must make sure I don't make any stupid mistakes in setting up a portfolio I can live with - be it three fund or CDs with an equity component. Thankfully, I discovered this site!

Am I alone?
I started investing with the purchase of my first mutual fund in July of 1984. I still own the fund and am still investing almost 31 years later. At age 55, I am not sure that I have got it all figured out either. I did the best I could with what I knew at the time and kept at it and so far things have turned out okay.

One thing that Warren Buffett said really clarified things for me. He said sometime like this, "Whenever you buy a stock or a bond, what you are really buying is a set of cash flows." Hmmm. Makes sense. I am buying something with money that hopefully will produce more money in the future.

Bonds are relatively simple. You are buying a promise to get paid a set interest rate for the life of a bond, at the maturity of the bond you get your money back. Principal plus interest.

Stocks are the purchase of a piece of a going concern business. That is a business that is expected to keep going into the foreseeable future. Businesses create cash flows by hopefully generating net income, that is what is left from income after you subtract out all the expenses. A collection of businesses owned in a mutual fund or an index fund can reasonably be expected to increase its net income or profit over time.

Business with slow growing profits will trade at a lower multiple of earnings than businesses with fast growing profits. What makes the cash flows from businesses particularly valuable is their ability to grow and over time grow faster than inflation. The cash flow from a bond will stay exactly the same from the time you buy it until the time it matures. So if you want to grow your portfolio, you want more stocks and less bonds. At the point you don't need much growth from your portfolio and want more stability, you want more bonds and less stocks.

Stocks are a bigger bet on the advances of human civilization and of human progress. As the economy grows, the earnings from businesses represented by stocks should grow right along with it. Stocks really are a proxy for the economy and for its component businesses.

So investing in many ways is an exercise in faith. We really don't know that humans will progress or that the economy will grow. But it has happened so far in human history and there is good evidence to suggest this will continue to happen.
A fool and his money are good for business.
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Re: How many really understand how investing works?

Post by abuss368 »

When folks such as Jack Bogle, who know more about investing then I ever will, throw up a flag and say the markets are gamed, then I will worry!
John C. Bogle: “Simplicity is the master key to financial success."
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Re: How many really understand how investing works?

Post by Call_Me_Op »

When you buy a stock, you are part owner of a company. When you buy a bond, you make a loan to some entity. These are the basics.
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Re: How many really understand how investing works?

Post by RadAudit »

[
rocko wrote:A side note:

The area in which I live contains many, many folks who live in multi-million dollar homes with all the trimmings. A significant number are hedge fund, capital venture, or equity capital guys (I say "guys" because I haven't encountered a single female in this category (sadly). Anyway, it's obvious that there are many super smart people in this world who know how to play the finance game... and I can't help thinking "I'm" the one (and millions like me) that they're making money off of!

Yet another layer to my investing paranoia.
Yes, there are smart people involved in hedge funds; but, sometimes you have to question where their competences may be. It may be more in sales than in investing. The Motley Fool has some insight in this article's last several paragraphs.

http://www.usatoday.com/story/money/201 ... /23678119/
FI is the best revenge. LBYM. Invest the rest. Stay the course. Die anyway. - PS: The cavalry isn't coming, kids. You are on your own.
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Re: How many really understand how investing works?

Post by Stan Dup »

"The tyranny of compounding expenses is the eighth deadly sin." - George Sisti
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Re: Super smart people ?

Post by abuss368 »

Taylor Larimore wrote:
It's obvious that there are many super smart people in this world who know how to play the finance game.
It may appear "obvious," but it's not. It's been said that the easiest way to make a million dollars is to start with ten million dollars. Another way is to do what the casino owners do: Become the croupier instead of a customer.

This is a quote from The Bogleheads' Guide to Investing:
Mensa is an exclusive society whose membership is restricted to persons scoring in the top 2 percent on IQ tests. During a 15-year period when the S&P 500 had average annual returns of 15.3 percent, the Mensa Investment Club's performance averaged returns of only 2.5 percent.
Best wishes.
Taylor
Everytime I read that quote, it makes me stop and think.
John C. Bogle: “Simplicity is the master key to financial success."
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dratkinson
Posts: 6108
Joined: Thu Jul 26, 2007 6:23 pm
Location: Centennial CO

Re: How many really understand how investing works?

Post by dratkinson »

People need products and services to live. Businesses supply products and services to consumers (people) for an expected profit.

Businesses need capital to operate. Investors, through the investment markets (stock, bond) supply businesses with needed capital for an expected return/profit.

The population (people) is expected to grow exponentially, so linked business demand/market growth/investor return is also expected to grow exponentially.

The return of the average investor is the market return, less all investing costs.

Active investing is guaranteed to increase investing costs, but without a corresponding guarantee of increased market return, so passive investing is the preferred (lowest-cost) way of earning most of the market's return.
d.r.a., not dr.a. | I'm a novice investor; you are forewarned.
reneeh63
Posts: 236
Joined: Wed Dec 17, 2014 6:12 pm

Re: How many really understand how investing works?

Post by reneeh63 »

I understand WANTING to know all the inside "guts" of investing in terms of giving you more confidence. For me though that seems akin to wanting to understand how the electronics of a tv or laptop works....it's fine...and interesting...but really has very little impact on what I actually DO with it.

I'm following a 1) no market timing 2) well-diversified portfolio 3) let it ride 4) low expense strategy. I don't really care what happens inside a company or how markets work...as long as I make the money I need for my goals. Don't let a lack of THAT kind of knowledge stop you from getting started.
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