This is Why You Can’t Make Money in the Stock Market

In just the past decade or so many investors have been burned. Twice. Those who did a lot of investing in the late 1990s and early 2000s clearly remember the pain as their tech-heavy portfolios tanked in record time. It then took a few years to stabilize, and then a few more years to recover. We only have to look back a few years to see the same thing happen yet again. The stock market rallied for nearly five years starting in 2003 only to once again peak and subsequently crash in dramatic fashion leaving investors wondering why they even invest in stocks at all.

This isn’t anything new. The stock market is always in flux and there are periods of bull and bear markets. Unfortunately, the last decade has displayed some exaggerated bull and bear markets adding more volatility than generations past had to deal with. Ultimately, this extreme volatility and human nature are what cause so many people to lose money and faith in stocks. It’s not that stocks are a bad investment, rather it’s usually the fact that people do the exact opposite of what they have  been taught that causes the pain of losing money.

It’s All in the Recent Headlines

If you want to see dumb investors in action, just check out some of the articles in the media coming on the heals of the best two year stock market rally in history. Investors flood back into stocks (March, 2011), investors ease back into stocks (November, 2010), experts say to get back into stocks (January, 2011), richest investors come back to large-cap stocks (February, 2011), main street investors change their strategies (February, 2011). These are just a few, but every week it seems like new data is coming out showing more people flooding to stocks.

If these stories weren’t so sad, it would be comical. When these articles talk to real investors it can be almost shocking to see the destruction of wealth based on nothing more than poor timing due to human emotion. A common theme can be found in this quote from the most recent story from above:

“It didn’t feel right to be back in until now,” says Richard Dukas, who heads a public relations firm in New York City. “I still don’t want to put all my money in the market, but I believe we’ve come through the worst of it.”

After the 2008 financial meltdown, Dukas and his wife converted their 401(k) retirement accounts into cash. They had been burned during the bubble in technology stocks a decade ago, and Dukas says he has been “extremely skittish” ever since.

Now Dukas, 48, says 85 percent of his portfolio is back in mutual funds, although he maintains a small cushion of cash.

If anything, this is probably the most typical scenario I’ve come across in both my time working with investors and in helping friends and family navigate their investment strategy. Just look at the quote above and you’ll see how poor of a decision that was. First, they waited until after the 2008 financial meltdown before cashing out their stocks. That’s mistake number one. By the time they sold, all the damage had been done and they locked in a 40-50% loss. Second, in the article he says it now feels like it’s finally time to get back in and now has 85% of his portfolio back in stocks. Problem number two is that they let the two best years in stock market history pass them by which would have helped them recover the bulk of their losses, and instead are now buying back in at what appears to be the peak of a bull market. They sold low and are buying high. You can’t make money that way.

The common thread is that in the past six months or so the trend is for more money to be going into stocks than cash or bonds, which has been the trend over the last couple of years. How ironic is that? In 2009 and 2010 the majority of money being invested was by far going into cash or bond assets, yet the market was tacking on gains at a record clip. Today, after the market has bounced back nearly 100% from its lows, it’s only now that investors are feeling comfortable to invest in stocks again.

To better illustrate this perilous investing behavior, here’s a quick chart:

Just like Richard in the article mentioned above, he had seen enough in late 2008 and decided it was time to bail out of the market. Well, as you can clearly see, by the time the end of 2008 rolled around the bulk of the damage had already been done. The S&P was already down between 30-40% at this point. Granted, it still had more downside yet to come and you can argue that selling then missed that, but look at how quickly the market recovered from that ultimate low. Had you not been paying attention to the news a month or two would have gone by and you wouldn’t even have known. And from that point forward the market has been going up sharply.

So, as you look at the chart you’ll notice that 2009 was the year to invest if you had the foresight to invest early in the year. The market rallied close to 65% in just nine short months. That’s unheard of, but guess what? John Q. Public investor missed out. They got shaken by the sharp drop in October of 2008 and bailed out completely, and being afraid of the volatility in the market probably let 2009 and most of 2010 go by before realizing the market rally is real and they should probably get back in. It doesn’t take rocket science to see the problem with these two circles. The “sell” circle is lower than the “buy” circle, and you don’t make money selling low and buying high.

The Missed Buying Opportunity

It isn’t just the wholesale selling of stocks and buying back in later that can cause damage to your portfolio. We all know that if you sold after the crash and waited two years after a rally to buy back in that’s a losing proposition, but there’s another layer of missed opportunity here. When most people sold their stocks back in 2008-2009, they also stopped putting new money into stocks (if they were investing at all). That’s what many of those articles referenced above point out, that for those two years the bulk of new money being invested was going to cash or bonds. Well, what a wasted opportunity.

Had you continued to make regular investments in your 401(k) or IRA or whatever you use into your stock holdings during that down period of a year or two you would have racked up a nice amount of money that had an average purchase price well below the peak from just a few months prior. In most cases, that money would have been buying stocks at a 25-40% discount only to then rally in the coming year and earn you a hefty profit. Instead, most people turned to cash or bonds for all of their new money and while stocks were setting record gains, they were content earning 1-5% on their money.

The gains are real. As I wrote about in the lost decade of investing, those who took the tried and true approach of regularly investing over time in a diversified portfolio and rebalanced regularly, came out ahead. While the decade of stocks is “lost” on paper showing a negative total return, a real investor who didn’t make rash emotional decisions and stuck to their guns actually made money in a period where people claim it would have been better to put your money under a mattress.

Lessons to be Learned

“Those that fail to learn from history are doomed to repeat it.” That quote pretty much sums it up because it’s true. Sure, it’s easy to look back over the past few years and see where everybody went wrong. When you’re living in the moment and staring into the teeth of a bear market it can shake even the most astute investor. But as history has also shown, the world didn’t come crashing down and a rash decision often proved costly.

With every market dip there are people who proclaim that this time is different. This is the time where the country goes bankrupt, your cash is worthless, and the best investment is that of guns and ammo. Well, maybe that day will eventually come, but I’m willing to bet that’s far less likely than some would lead you to believe. We’ve had countless market downturns over the past 100 years, each caused by a different driving force, yet somehow we’ve managed.

So, the key here is to learn from history so you don’t continue to make the same mistakes. Don’t wait until the market goes down, sell all of your stocks for a loss, and then wait well into a subsequent rally to buy back in. When you react to what has already happened, you’ve already lost. The only way to make money timing the market is to be ahead of the curve. You need to sell before stocks go down and buy before they go up. For the average investor you’re probably better off going to Vegas and playing blackjack.

The rules haven’t really changed even though the economy has.

  1. You need to create a diversified portfolio.
  2. You need to regularly invest, in good times and bad.
  3. You need to rebalance your portfolio regularly.

It’s that simple, yet adhering to it can be difficult. Ultimately, at the very least you need to diversify. Most people, especially those later in life, are overexposed to stocks. Sure, everybody wants to play catch-up since they got a late start in saving, but taking on more risk isn’t the answer. So creating a portfolio with a solid asset allocation might not be flashy or make you rich overnight, it will do the dirty work of mitigating risk so you aren’t left to your own devices and trying to time the market. Second, you need to continuously invest. When you invest on a fixed schedule it doesn’t matter what the market is doing. Sometimes you’ll be buying low and sometimes high, but in the end you’re going to end up with even more money than if you had been on the sidelines. And finally, rebalancing is important because it forces you to take profits off the table. As the investments in your portfolio do good or bad their proportion gets thrown off your target. By rebalancing you’re then taking profits from the investments that did good and shuffling them into the investments that aren’t doing so good, which is effectively selling high and buying low.

One final thought, and that has to do with Warren Buffett. He’s known for saying, “Be fearful when others are greedy, and greedy when others are fearful.” Since the public is usually the last one to the party, I’m a bit on the fearful side these days. While mainstream media says it’s time to get back in, I’m doing the opposite and pulling some of the profits from the past few years off the table. I don’t move my entire portfolio in and out of stocks like a fool, but in times like these I am extra careful about buying into the excitement.

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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.

24 comments
rodcabnc
rodcabnc

One major reason to be skeptical about making money in the Market is the fact that unfortunately nothing has changed, the root cause of the past market crashes still prevail, that is Wall Street corruption. Only Day traders are more likely to make money because they never hold any open position for the next day. I have to wait for the next day to sell, but the next day, market makers have the power to open the stock lower and  you lost your money. It is a win/win for the big sharks, but much harder little players. If you hold the stock will zigzag over the course of your holding, when you open your eyes, your profits will be gone, taken by the sharks creating the zigzag. I am still playing the market, but it is disappointing.

Dan Mac
Dan Mac

It's a great lesson you are teaching here.  Investing doesn't have to be that difficult but unfortunately human emotion makes it a challange.  It's easy to say you will hold through big market declines because you realize the market will come back strong later while it's difficult to actually do it when it's your livelihood that is at risk.  My portfolio is still small so not that challanging to watch a 50% drop when it means little money actually involved.  I may have a much bigger challange when a 50% drop means $500,000 of losses.  But I'd hope I would stick to my plan and do the right thing.

Unfortunately, based on the comments it seems that most people just don't get it.  If people are going to act irrational and make poor decisions then they may be better off not investing at all.

thefrugaltoad
thefrugaltoad

I've done slightly better than the market most years by doing exactly what you outlined above.  When I actively managed my own small portfolio of stocks I always got burned.  I had stop orders in place to "protect" myself on the downside but almost always was wrong on the timing of getting back into the market.  When most full-time stock traders are wrong on buy/sell points, why would anyone try to actively manage their own portfolio?

Sterman7
Sterman7

While I agree with some of the premise of your article the one thing that investors should keep in mind is that it is true that the market has come through in the past but the tools to do so seem to be spent. Consider the response to the last two market crashes were lowering interstate rates and bailouts. good luck lowering rates and more bailouts of any size are unlikely. The reality is the global financial system is fragile and history shows that monetary regimes change and volatility comes in those periods of change. The key today is carrying wealth forward to the next multi-year bull market. Good post for stirring the discussion.

PFPro
PFPro

I was a little worried by the title but you do a good job explaining how you can make money, buy and hold, stick to your AA, buy low, sell high.  I know it sounds a lot easier than it is but that's what you have to do.  The stock market is killing it right now but most people should probably be re-balancing and shifting more towards bonds right about now(short term ones though haha).  

PipsToday
PipsToday

Jeremy Vohwinkle, there is a huge list of articles and experts' suggestion where some say, people can not make money in stock market while some say there is lots of opportunity to make money in stock market. The number of investors is increasing despite these all things. I am not agree with you for this "You need to regularly invest, in good times and bad." but standing with you for these "You need to create a diversified portfolio" and "You need to rebalance your portfolio regularly."   

Chad CO
Chad CO

A lot of different opinions here about a lot of different subjects.  I think overall you can make money in the stock market you just have to change the way you approach it.  I was a stock broker for years and saw people getting killed trying to dollar cost average. They were always fearful when downturns hit and always sold at a deep loss.  Despite one of the comments here, technical analysis does work.  It's not perfect, but does work.  It's what I use to look at the direction of the overall market and then buy, hold, sell, or short the market.  Technical analysis has really developed beyond drawing lines on a chart.  There are now a lot of indicators that give the underlying tone of the market which tends to measure "conviction" about the current market direction.  I try and do my best to demonstrate these sentiments on my blog: everyinvestor.blogspot.com so that average person who does not understand all the intricacies of the analysis can follow along

Pinksheet Stocks
Pinksheet Stocks

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RecardoMandy
RecardoMandy

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Jacob @ My Personal Finance Journey
Jacob @ My Personal Finance Journey

Wonderful article here! I'd like to believe in a strategy that enabled investors to make money on individual stocks, but the evidence just isn't there.

I love how just now the financial news is advising people to get back in to stocks! That's probably a signal to start selling off some of your shares.

I think this evidence just further strengthens the case for a passive investing index mutual fund approach with appropriate asset allocation targets.

J @ Your Own Retirement
J @ Your Own Retirement

It has really been a strange few years for investors and stock holders across all industries. I think there is a light at the end of the tunnel I am just not sure where in the tunnel we are at.

Geo
Geo

If your looking for the best stock that has come into play in the last year, check out ORT.A in the TSXVenture. The name is ORBITE in Que. Can. Do your own reading.

Jason the Saj
Jason the Saj

Sorry, but I think the market/mutual fund/IRA is nothing more than bovine fecal matter.

Look, I got in right after the 1990 dot com stock market crash. I was in until I saw the next crash. And thankfully pulled out most of my money before the 2008 crash.

But after a decade of investment during the so-called "good years" I had found that I got very very little return on my investment.

All the mutual funds that I was invested in pretty much continued to bleed money the whole time. I'd honestly probably have done better to just buy a CD with decent rates than to have been in the game.

Mutual funds are NOT for our benefit, they exist to benefit the economy. They are lose-lose machines. They are chartered to specific type of investments, and so they must weather through a bust.

Ironically, the two investments that did well were the two I was told I shouldn't invest in. One was a small company called Netflix. Bought the stock back when it was $9-$15 and told they'd never survive. Had to sell it due to job loss at $130. Had I not lost the job it'd be nearly 20x return on investment.

The other investment was silver. Oh, I was laughed at for that. Bought a lot around the $10 mark.

--

I've come to the conclusion that IRAs/401Ks don't work. Everyone I know has pretty much lost money or not gotten the returns that are so often marketed.

Sure, the DOW Jones is higher than ever. But how many companies are listed on the DOW Jones today that were there 10 yrs ago? 20 yrs ago? 50 yrs ago?

Even big names like GM are gone from the stock market. These dropped companies are seldom factored into the equation.

Let's be honest. You're better off picking a few decent stocks or greatly diversifying your accounts ie: 1/5 stocks, realty, gold/silver/assets, cash/currency, agriculture (plant gardens, trees, etc).

Rubin
Rubin

The article talks about timing in general, attempts to echo the wisdom of Warren Buffett but never really addresses "buy" criteria from a value investor perspective. Buffett also said, "Price is what you pay, value is what you get."

There are bargains to be had at any given time on any market. The key is not market timing, which is a lot of nonsense... as is any kind of technical analysis. Buffett and other value investors of the Benjamin Graham school of thought essentially look for companies whose market price is below its book value or intrinsic value. These kind of companies, while scarce in supply, are possible to find in any market. The idea is as simple as buying a dollar of assets for less than a dollar, and then selling it at some later time when the market is dumb enough to overprice that particular asset... which can occur in any market.

Time horizons for such transactions may be years or decades... returns won't be extraordinary most of the time but they will be solid, and they'll compound over time... yielding better results than trying to reach for growth with every transaction. Protection of principal is far more important than reaching for unsustainable rates of return. Why? Because if you risk loss of principal, you compound your losses over time... Eliminated principal greatly reduces your ability to enjoy the exponential effects of compound interest over time. Or, put another way, any rate of return times zero principal is still zero.

Memorize these words by Benjamin Graham, and stop reading self-help guru websites: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

Kyle V.
Kyle V.

So I have a question that has been nagging me from the back of my mind and was wondering what some of you thought. When talking about rebalancing I frequently read about selling assets which are doing well and buying those that aren't doing as well. So if I'm investing in stocks and bonds regularly (in order to take advantage of dollar cost averaging) and now think that maybe stocks (in general) are becoming a bit over priced, should I sell some of my stocks to take the profit and put it into bonds or should I skew the percentage I contribute more towards bonds? Is there really any difference? I guess there would be if the portfolio to contribution ratio is large enough (because you might miss the optimal rebalancing window).

Sandy @ yesiamcheap
Sandy @ yesiamcheap

This is why the entire concept of dollar cost averaging comes in handy. If you understand it then you're less apt to run when prices fall and instead continue buying thereby lowering your average cost.

Courtney
Courtney

All this is very true and very good. But also important is taking on the appropriate amount of risk for your age, goals, and tolerance level. And I think that's another thing Mr. Dukas is doing wrong - at 48 (and having already proven himself as a skittish investor), he should only have somewhere between 55-70% of his portfolio in stocks. I'm nearly 20 years younger than Mr. Dukas and am only 80% stocks.

Echo
Echo

Early 2009 was probably the best buying opportunity of our lives, but like you said most people were only buying into the mass hysteria that the world economy was collapsing. They sold at the bottom and locked into fixed income investments, and maybe now they are taking those investments and putting them back in the market.

Meanwhile, smart folks held on and picked up some great bargains in early '09...ones that were paying juicy dividends.

Jim D
Jim D

Good comments STU and Ron. Dividend stocks are less volatile overall. And buy and hold will not lose money long term if you diversify enough and re-balance. But then locking in 5 - 7% annual gains long term is not what some people expect from the markets.

STU LACH
STU LACH

DIVIDENDS DIVIDENDS DIVIDENDS TWIT!

Pat S.
Pat S.

You've got to take your feelings out of the equation. Invest with your mind, not your emotions. If you mix the two up, you are doomed.
Pat S.

Kathryn C
Kathryn C

I hear you....it's against our human nature to cut back on something that's doing us good. So when stocks are ripping, to pair back and rebalance is tough because we feel like we're leaving a REALLY GOOD PARTY too early!
Also, to buy when prices are low, it's like we're the first person at the party...... and feel like a loser being the first one there. It's all in our head and it's a big problem.

I like to get to the party early so I can catch up with host before it gets busy, then leave early so people wonder where I'm going!
Kathryn

Ron
Ron

"Those who followed a Buy-and-Hold approach (buying stocks regardless of price) always end up selling at the wrong time."

Curious how you sell a sock if you're "holding" it.

DonB
DonB

I always think of herd behavior as the source of inflation-outpacing returns of volatile investments like stocks. It's a simple money transfer from those who don't get it to those who do.

Rob Bennett
Rob Bennett

I very much agree with the Warren Buffett quote. But that's not really what you are endorsing when you say that people should "regularly" put money into stocks and leave it there, Jeremy. If others are being "greedy," you should be "fearful" -- at times of high valuations, you should STOP putting money into stocks.

Those who have followed that practice have never done poorly with stocks going as far back as we have records. Those who followed a Buy-and-Hold approach (buying stocks regardless of price) always end up selling at the wrong time. The losses that follow from buying stocks without regard to price are just too huge for the middle-class investor to take.

Rob

MC
MC

I stuck w/ my investments for my 401(k) and upped it by a couple of percentage points. Now I'm more regretful for not buying more. Right now, being 32, I'm not to concerned with a pull back because my horizon is still long for that money. I have been increasing my % each year until I get to the max. Hopefully sooner than later.

Barbara
Barbara

Hi. I also am confused as to when i have a stock such as CMG today, I was already at a loss and didnt want to sell at a bigger loss but by the end of the day i was down 24.00. maybe a stop and losing 800.00 is better but how do you know if tomorrow it will go up? thanks

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