The volatile nature of the US stock market has never been more evident than today: often rising and falling based on things like world affairs, impending conflicts and trade agreements and embargos. And while you may think none of these things – including the markets themselves – actually impact you, think again; because we are all almost inevitably intertwined with this centuries-old American financial institution, one way or another.
If you have money set aside as an investment or for your eventual retirement, there’s a good chance that some of that money is tied to the stock market in some way. You may not directly interact with stocks, indexes or financial instruments, but somewhere, it’s likely that you or your money will deal with the stock exchange on some level at some point in your life.
But after the financial collapse of 2008 – and with new threats emerging on a seemingly daily basis – there’s more confusion and concern about whether individuals should be investing in the stock market than ever before. Are the markets just another form of gambling? Is it hopelessly rigged against the average investor? Is it simply not the vehicle for investment that it once was? Let’s take a look at these questions and others to better understand how the stock market works for the modern investor.
The Good Old Days vs. Today’s Market
If you ask anyone to compare the stock markets of today to those 30, 50, or 100 years ago, you’ll likely hear a tale of how much better things were way back then. Of course, people say that about everything, so it’s likely to go in one ear and out the other. But what really distinguishes the stock market of today from that of a few decades ago?
Obviously, the market moves much faster today. Ever since the advent of electronic trading – which can be traced back to the opening of the NASDAQ exchange in 1971 – it was clear that the inner workings of the stock market would never be the same. And while NASDAQ only quoted prices electronically and still required trades to be made in person, the next few decades would see electronic trading become available and increasingly popular.
The expanded use of electronic trading has been part of what has scared many away from the stock market, or at least increased their fear of it. With stories of high-frequency traders (which we’ll talk about more a bit later), it can be easy to see the electronic market as a huge step back for the average individual who just wants to occasionally buy and sell a few shares to adjust their portfolio.
But in reality, almost all of the changes brought on by electronic trading have benefited investors. Electronic trading has lowered the spread between bid and ask prices, which was great for traders, but hated by brokerages that made a great deal of their profits because of that gap. Long gone are the days when the spread might be as large as an eighth or a quarter of a dollar, allowing both sales and purchases to be made much closer to a “true” market price.
Electronic trading has also helped to reduce the costs of trading for investors, and made it easier for individuals to interact with the market. Prices are easily found at any time online – a slight improvement over the first century or so of the New York Stock Exchange, when there were no indexes and little way to tell if you were buying or selling at an honest price – and there’s more liquidity between buyers and sellers, making markets more efficient. In all of these ways, the modern market works far better for investors than it did in the past.
Of course, electronic trading just explains the differences in how we work with markets. Perhaps even more dramatic have been the changes in stock markets themselves, especially if you’re willing to look far enough back.
Imagine you were to look at the totality of the US markets in the year 1900. Not surprisingly, railroads were the dominant force in the stock market then: they were really the only way to get across the country, and were incredibly vital for the transfer of goods throughout the nation. No matter what industry you were in, railroads mattered. Far behind them, financial institutions and iron, coal and steel companies were also important to the turn-of-the-century stock markets.
Now try jumping forward 100 years to the turn of the millennium. In the year 2000, railroads were barely a blip on the radar, and while the banks had grown in importance, the biggest sector of all was information technology. Pharmaceuticals, retailers and telecommunications were also far bigger sectors than anyone could have imagined a century earlier.
What’s the point of this comparison? Simply that what matters today may be vastly different than what people are investing in decades from now. That’s neither a good nor a bad thing inherently, but it’s important to remember it as we continue talking about the risks and rewards of the modern stock market.
Is Playing the Stock Market Just Another Form of Gambling?
To many, putting money in the stock market feels like nothing more than a gamble – not much different than playing roulette at a casino (albeit with the house advantage perhaps being with the investor more often than not). Is that really an accurate way to think about the market, though?
In reality, there are many facets of investing in the stock market that are like gambling. After all, you’re putting money at risk on an uncertain outcome, and that’s about the most straightforward definition of gambling you can come up with. Even though the long-term trajectory of American stock exchanges has pretty much always been positive, that alone doesn’t stop investing from becoming a form of gambling: after all, the casino or bookmaker is gambling just as much as their customer is (they just have a nice edge).
Some of the same dangers inherent in gambling are also potential issues when investing. It’s possible for investors to get addicted to the thrill of risk and potentially big rewards – it’s certainly easy to play the market much like you would a slot machine, if that’s what you want to do.
That all said, there are aspects of investing in stocks that separate this activity pretty definitively from typical gambling activities. When you buy a stock, you actually own something: you have a fraction of the company that you can call your own, and you get to have a piece of the company’s profits. If you invest in a firm that’s making money, you may well receive dividends just by holding on to your stock.
Because investors are buying into companies, that means that they’re actually (or at least, potentially) adding value to the economy by helping those firms produce more goods or services, compete against each other to innovate and develop new products. In contrast, nothing is ever created through gambling: someone wins, and someone else loses.
In a more casual sense, people may look at investing as gambling simply in the sense that there’s no way to accurately predict whether they’ll make or lose money on a given stock. In the short-term, that’s pretty true: the fluctuations in a stock’s price are more or less random. But over the long run, stock prices tend to reflect the profits a company can deliver (and the resulting dividends those profits produce): the more money a company makes, the higher the stock price. That means that for those who simply want to hold a stock for the long run, the results are a bit more predictable than many people might think.
Is It Safe to Invest in Today’s Market?
And that brings us back to the most important question of all: is it safe for the average person to invest in the stock market today? It’s not a question with a simple answer, and experts differ in their opinions on whether the risk to the typical investor has increased or decreased in recent years.
The most recent topic that has brought this question back to public attention is that of high-frequency traders. The practice became part of the public consciousness earlier this year while Michael Lewis was promoting his latest book, “Flash Boys: A Wall Street Revolt.” It told the tale of how firms looked for an advantage of milliseconds in order to beat other investors to the most current prices for stocks, manipulating the markets through buying and selling just before others could in order to eek out extra profits.
The ins and outs of high-frequency trading are complex, varied, and well beyond the scope of this post. But essentially, these firms thrive on getting the quickest possible access to information on how the market is moving, using predictive algorithms to analyze the data, and then reacting faster than the general crowd of investors can. It’s potentially similar to insider trading, but doesn’t seem to actually be against any current regulations.
This is certainly harmful to other investors who are trying to make trades in real time: even if a price drops or rises by a penny or two, that can be costly over the course of many trades. It’s an important issue and one that has caught the public’s attention to be sure.
But on the other hand, it has very little effect on those simply looking to invest for the long term by buying and holding stocks. While the short-term prices of stocks are changed, the long-term trends aren’t really impacted by high-frequency trading – meaning that your retirement fund isn’t going to go belly up because of these ultra-fast traders.
So that means that it’s entirely safe to go back to your “buy and hold” strategy, right? Probably: but remember, there’s no such thing as a sure thing.
Remember when we talked about how different the stock market looked a century ago? That’s important to take into account when considering just how “safe” your investments are in the long run. You’ve likely heard that over the long-term (the time period specifics differing depending on what exactly is being discussed), holding a broad base of stocks in an exchange or index has always turned a profit. Even after the Great Depression or the 2008 recession, those who held steady eventually made plenty of money.
That’s always been true in the United States – but that’s not typical of all countries everywhere in the world. And given that reality, some experts have argued that the last century or so of American stock markets may have been the exception and not the rule for markets in general. In other words, past performance is not a guarantee of future results, and you may want not want to rely on any one stock (or one market) to make you a millionaire.
That doesn’t mean that the stock market is going to fall apart, or that we’re heading for another boom: you can find pundits predicting both for the next few years and decades, but as history has shown, these sorts of predictions have not been terribly accurate. But it does mean that investing has and always will involve some degree of risk – and while the tools we have to invest may be better than ever, they can’t allow us to say with any certainty what the market will do next.