When is the stock market a good idea?

Question

I'm your average person. I have an education, with 2 years of college in an area unrelated to finance. I have a 401k, and a disposable income. I'd like to invest some of this income. There are many ways to invest, but one that piques my interest is the stock market.

It's cultural in the United States to know that the stock market holds the epitome of risk & reward. You can lose everything or make it big. My question is, when is the stock market worth looking at from an investment standpoint? You can assume I'm a long-term investor (1yr+), and I don't have the time or energy to fiddle with frequent trading. There are various factors here that I'd like to evaluate, including:

• Are stocks in my area of expertise / educational background better for me to invest in?
• How it compares to other forms of investment?
• How do I tell if it's a good investment avenue for me?

Answer 1

Quick answers/opinion:

• The stock market can be good for people who don't want to tie up their cash in longer term/less liquid assets like property.
• Investing in an index or sector ETF might be better than you trying to pick stocks or theme yourself
• Never invest more than you can afford to lose (though it's rare you lose everything).
• Understand a few edge cases around frequent trading/wash sales and capital gains tax so you understand the implications when you need to sell.
• Pick a broker that is accredited, certified, insured etc. You probably want execution only unless you want serious advice. Check fees.

So, yeah, go for it. It's a good option for almost anyone, easy to get in & out of and relatively cheap. Just bear in mind

• You probably won't make $millions on a few $k investment unless you go high risk. - Be happy with above-interest rate returns unless you are going to research heavily.
• Time in market is generally more important than timing your trade (no matter how fun it is!)
• If you don't use ETFs then remember diversification is important to spread risk

Answer 2

The stock market is as risky and time-consuming as you want it to be.

Ways to either make or lose a lot of money in a short time are option trading and short sales. These are the subject of those "wallstreet bets" stories you might have heard of where people double their life-savings in a month just to lose them all in the next. But as a beginner you would be well-advised to stay away from those.

The key to low-risk long-term stock investment is diversification. Which means buying stocks of lots of different companies. If one of those companies crashes, you only lose a tiny part of your investment.

You can of course pick companies yourself. But an even easier and less time-consuming method is to let others do the picking for you and just invest into an index fund or managed fund. These funds are parcels of stocks of many different companies. Index funds always contain the stocks of companies included in a stock index like NASDAQ, EURO STOXX or DAX. Managed funds are stock portfolios hand-picked by a broker.

Some people might find reading stock market news fun and exciting, and love to geek out over all the intricacies of financial instrument trading. But most people just have better things to do with their lifes. A common strategy for these people to still benefit from the stock market is to just put a fixed amount every month into a well-diversified index fund and not look at it until they need money. And because the long-term tendency of the stock market over the past 100 years was constantly upwards, and all the big market crashes are just temporary, this usually worked out pretty well for them.

Answer 3

The stock market is not "the epitome of risk and reward". It is a tool. In general the use of that tool involves trading risk against reward; the way people get you to invest in riskier ventures is by offering higher (potential) rewards for doing so -- exactly as a bank demands higher rates when making riskier loans.

You can, and should, pick your investments to reflect the amount of risk you are willing to tolerate, considering the time horizon at which you are going to need the money and your own confidence or lack thereof in each investment and in the general prospects of the economy. Risk can be managed, in part, by diversifying your investments.

As discussed in many other answers, you can get roughly "market rate of return" over the long term with nothing riskier or more complicated than a small set of index funds, adjusting the balance between them to suit your comfort with the market. A fee-only investment advisor can set you up with such a strategy in just one or two one-hour sessions, and you may not need to get further advice for the next decade or two unless your financial situation changes. That's a "boring" way to invest in the stock market, but if you don't actually want excitement it's by far the simplest approach.

If you can't tolerate any risk, or will need the money soon, stick with FDIC-insured accounts -- high-interest savings accounts and CDs currently offer low but nontrivial interest rates.

If you are asking for a definition of "soon" ... That gets back to the question of what your personal risk tolerance is.

Answer 4

When is the stock market worth looking at from an investment standpoint

When the Shiller P/E ratio is at its historical average levels, you can be almost certain the stock market is a very good investment for an intermediate period of 10-15 years.

You can see the Shiller P/E ratio here: https://www.multpl.com/shiller-pe

Today (4.8.2023) it's 30.89. This means that E/P ratio is 3.24%. Note that this is the earnings that companies are free to use to pay dividends. However, a company that pays all of its earning as dividends and doesn't invest into growth can't be expected to grow more than about 2% per year (inflation level target). So today you would expect 5.24% yield if you invest into S&P 500 index.

Also you should consider reversion to the mean. There's a law that securities tend to revert to their mean historical pricing levels. So if Shiller P/E ratio reverts to 17.05, this means a multiplication by 17.05/30.89 = 0.552 or 44.8% decrease.

So for example for a 15-year investment, if the reversion to the mean happens in the end, you get 1.0524^15 * 0.552 = 1.1875x the money back you invested. This is 1.0115^15 so there's a very major possibility if you today invest into S&P 500 for a 15-year period, that you would get only 1.15% annually, less than inflation.

However, the outlook may not be as dim as you would expect based on S&P 500 and Shiller P/E ratio alone.

Firstly, today companies are often paying investors in stock repurchases instead of dividends. This means an individual stock has higher earnings growth than they used to in history. The Shiller P/E ratio uses only inflation adjustment, not stock repurchase adjustment. Secondly, mergers and acquisitions are today very common and companies have to depreciate "goodwill" from their balance sheet immediately if they see its value has diminished. Thus, you will see lots of goodwill depreciation, which tends to reduce earnings. But you never see goodwill appreciation, if some acquisition turned out to be a very good idea, meaning it had more value than what was paid, you don't see a one-time positive earnings from that.

Thirdly, why the S&P 500 is at such expensive level today can be seen by just looking at its major components:

1. Apple: horribly overvalued
2. Microsoft: horribly overvalued
3. Amazon: horribly overvalued
4. Nvidia: horribly overvalued
5. Alphabet/Google A: horribly overvalued
6. Tesla: horribly overvalued
7. Meta/Facebook: horribly overvalued
8. Alphabet/Google C: horribly overvalued
9. Berkshire Hathaway: finally, we have a sensible investment in the list!
10. Unitedhealth: I don't know anything about this

So at least 8 out of the 10 largest holdings are massively overvalued, to the point you shouldn't invest into them.

We are in the middle of the second tech bubble. The first tech bubble was driven by vague promises of future earnings, and investors lost a lot of money into worthless companies. The second tech bubble is more massive: it's not in the form of worthless companies having valuation, but it's in the form of companies doing great business but that just happen to be valued at 2-10 times what a reasonable investor would pay for them.

If you avoid those overvalued companies, you may very well decrease the Shiller P/E ratio of your stock portfolio, meaning increased E/P ratio and increased yield. And if the second tech bubble ever ends, you won't lose your money into that.

I believe it's entirely reasonable to build a portfolio today with Shiller P/E ratio of 18-20, meaning 5 - 5.5% yield plus inflation or 7 - 7.5% yield. Lower than historical returns, but still pretty darn good. Beats bonds quite well.

Also, if you don't limit your investments to US stock market only, you will see that the investment opportunities that have sensible valuation will be massive. US stock market is generally overvalued today, but the global stock market certainly isn't.