Why buy a stock? Why is a stock worth anything? You can eat food–that’s worth something, you can live in a house–that’s also worth something but what about stock?
I’ve been running a personal survey for some time asking this question and most people provide one of three answers.
If your answer is:
- “I don’t know” — Keep reading and you can add knowledge to your honesty.
- “Because I can sell it to somebody else” — Don’t kick the can down the road, you need to know why that “somebody else” or you should want to buy it, so keep reading.
- “I don’t buy stocks, they’re not safe” — Read the answer to that next article, and read about stock safety and if investing is gambling, but you’ll get part of the answer here, so keep reading.
- If you answer anything else you’re in a tiny minority so please write a comment; I don’t want to leave anyone out.
The real answer is: because a stock gives you money.
An important question is how it does that. Companies sell services and products. That makes them money. Owning a stock means you are an owner of the company, so a fair share of the profit belongs to you.
A logical follow up question — how does that money get to you. There are two ways: 1) a company pays you a share of the profits–that’s what a stock dividend is. 2) a company makes money and grows to be more valuable–now it’s worth more. Ultimately reason 2 only functions because reason 1 exists. I.E. Eventually you always want to get money, not just the thrill of owning a bigger company.
Another important question is: How should I invest?
To be fair, there’s an alternate view–my buyer is the source of my profit.
There are two variants of that belief.
- The buyer is a Stupidly Trading Oddball Other Guy Entity (STOOGE) so he is buying too high and you are the Savvy Market Understanding Guy (SMUG). But the STOOGE thinks you are the STOOGE and he might well be right. In any case, you have made the stock market a casino and will have to endure the odds being against you and pay a commission. The decision on the buyer’s side is often made by people with multiple full time analysts–are you willing to spend 80 hours a day in research? A big buyer’s supercomputer is housed inside the stock exchange so it can react in microseconds. Exactly how fast are you?
- “But wait!”, you say, “I sell it to him because he thinks the price will go up, and he’ll sell it to someone else who thinks the price will go up.” This is the Greater Fool Theory, which we can thank for the Crash of 1987, the .COM bubble of 2000, the Japanese asset bubble of 2001, the credit crisis of 2008, and more. Much like believing the world is flat, this theory has a long intellectual history, just not a good one.
I hope this helps you clarify some basic realities of the stock market. Given the choice between speculating with the odds against you and investing with the odds for you, which is better? Speculators are foolishly trying to extract money from each other, but investors simply benefit from the fact that businesses produce. Which is more likely to succeed?
Usually, people want to avoid unnecessary taxes–except for one. That one they line up to pay, even though it’s a voluntary tax. Stranger yet, people think paying this tax makes them money. What strange, upside down world am I talking about?
How should we think about Powerball?
