Amateurs in the Stock Market

Here's a thought. Suppose Sachin Tendulkar or Michael Jordan wanted to be doctors. This was their long lost wish, that never got fulfilled not because they were bad in school, but because they chose a different profession to specialize in namely sports.

Now having retired, they have a lot of free time on their hands. With all the money and the free time, they decide to become surgeons. They read books on how to perform surgeries. They see youtube videos on it, they read blogs of famous surgeons, talk to their doctor friends. Heck they even attend 30 day classes that teach them how to safely cut open a body and remove the heart. They even get to practice this on a few dead frogs. After doing this for a few months, after reading every single book ever read by a surgeon, after watching countless surgery videos, after practicing hundreds of dissections on frogs, rats. They feel they are ready. They are ready to perform surgeries on humans. All they need now is a willing patient.

Now, would you get a surgery done by them?

The answer from any sane person would be no. Here's another story, one that's more real, one that happens with ordinary folk.

Adam is a 25 year old software engineer by profession. Zack is a 50 year old doctor. They are really good at what they do. Adam is a rising start in his company while Zack is a well respected doctor. After reading my blog on "The Power of Power(^)", they realize, their profession can make them linearly wealthy but now they want to be exponentially wealthy. They scratch their heads look around to see how they can achieve this. In the media, they see examples of entrepreneurs hitting it big, but that's a lot of hard work. They then come across examples of people dabbling in the stock market who have made millions for themselves. They read about Warren Buffet, Rakesh Jhunjhunwala, they hear stories of their friends who have bought and sold a stock at the right time and have made a lot of money.

"Hmm....Why don't we invest in the stock market?" they ask themselves. They go to a library, buy all the books on stocks. They buy every book written on Warren Buffet, subscribe to all the blogs on stock picking, watch youtube videos, watch the news, they even attend a 30 day crash course on the stock market. They go through all this information diligently, read everything two times over, like their life depended on it. They practice this new skill by opening a brokerage account. They start with small sums of money, buy a few stocks, sell them and make money. They get confident, read some more, buy few more stocks, make some more money.

This looks easy they think, if I am able to double $1000 in a month, imagine what I can do with my life savings. They decide to go for it.

Here's the question, would you trust your life savings with them or how many of you have tried to be an Adam or a Zack?

What I want you to understand is, picking stocks is a profession. It is not a hobby (unless you are okay with losing all your money). It is not like a game of golf that you try your hand at. It is like being a surgeon. You cannot just become a surgeon. You cannot practice a few dissections and start operating on a human. Anyone who says they can teach you to be excellent stock pickers in a few months or even years is lying, anyone who thinks they can be excellent stock pickers by reading a few reports, watching the news is fooling themselves.

Investing in the stock market is a serious business, it is definitely lucrative, and addictive. The thrill of easy money is what lures millions of people to gamble away their hard earned money.
The problem arises, because it is so easy to open a brokerage account (an account needed to trade stocks) and it has become very convenient to buy and sell stocks either through mobile applications or through a browser. Think about it, you need to attend classes and pass a test just to get your driver's license. You need none of these to open a trading account.

I remember, when I first opened an american trading account. The first thing I did was buy $1000 worth of paper gold. Paper gold is essentially like a stock that tracks the price of real gold. This stock cannot be exchanged for real gold when you sell it.  I saw the value of this purchase go up to $1300. Then I bought more, $2000 worth of it.

When I had to buy 20 grams of 24 karat physical gold which is about $700, I researched about the best Jewelry store in Dubai. I asked 3 different people about it, I checked 4 different locations of that store, I haggled with the sales person, I came back the next day after getting a second opinion and then bought it. I spent a week in trying to buy $700 worth of physical gold, while I would have spent a total of 30 seconds to buy $3000 of paper gold.

The online world is pretty dangerous, we don't have a sense for how much we are spending if done electronically. That's why trading stocks online is very dangerous. At the blink of an eye you can gamble away your savings on a stock.

The stock market is a playing field where the novice play against the experts. Amateurs who try to pick winners, trade for short term are essentially playing a basketball match with Michael Jordan or bowl against Sachin Tendulkar. Sure you might score a few points or bowl a few dot balls but at the end of the game, you will get creamed. (Note: if you are in the stock market for the fun of playing a match with the best and don't mind losing the game (money), I am all for it. But if your financial life depended on winning the game, then the stock market is not for you.)

Who are the Michael Jordan/Sachin Tendulkar's of the stock market you ask. These are investment professionals working on Wall Street, in hedge funds incorporated in tax havens, investing geniuses like Warren Buffet working from their home. These institutions spend thousands, hmm ... make that millions, actually make that billions of dollars to obtain information, technological advantages, to get the edge to beat other professionals and primarily amateurs like you.

Did you know that hedge funds hire journalists to snoop on companies, to get information about new products or failures before the general public knows about it? Did you know that satellite imaging is used to take photographs of Wal-Mart parking lots to see how their business is? Did you know that thousands of stock prices and news events are being analyzed by algorithms in nano-seconds and they make thousands of trades in milli-seconds? Hey amateur, you have no chance. Absolutely none.
If the stock market was an ocean, you are a blind, fin-less juicy fish floating among sharks.

Friends, you have specialized in a different field. You might be a doctor, an engineer, a pilot, a school teacher, a lawyer. If I told you, I could be better at your job than you in a month or year's time you will laugh at me. So don't try to do the reverse. Don't think that you can be an expert Stock picker (not that I am one), it won't happen. You might win a few games against other amateurs like you in the field. But sooner or later there will be a Michael Jordan whom you will play against and you know what will happen.

Am I telling you to avoid the Stock Market. Hell No, that's where the money is. That's where I hope to keep majority of my net worth. That's where the rich really create their wealth. There are safer ways to invest in the stock market than for amateurs to buy and sell stocks. (More on that in my next blog). That's my point.

The Power of (Power)^

Heres a fun quiz, Suppose there is a bacterium in a test tube. This bacterium splits itself in two, every second. So in 1 second there are two bacteria. In two seconds there are four and so on. Now it takes the bacteria 10,000 years to fill one fourth the test tube. How many seconds does it take to fill the entire test tube?

I know most of you have come across this question in some form or the other before, but for those who couldn't figure it out it is "2" seconds. The answer 2 seconds is true if the bacteria took 1 billion years or 1 year to fill one fourth the test tube.

This post is on one of my favorite topics, Exponential Growth. Exponential Growth is all around us. Let me give you a few examples

Population - There were approximately 1 billion people in the year 1750.  It took 175 years to add a billion people i.e. 1925 the population was 2 billion. It took 35 years after that for the next billion. 15 years after that for the next billion. 11 years for the next, and now every 10 years after that we are adding a billion people on Earth, much like the bacteria in the test tube. If we were to make a hypothetical extrapolation of this growth, given enough time there will be a stage when we will add a billion people every year, then every month, every day, every second.

Computing Power - This is one phenomenon we can relate to. Every year computer speeds/memory gets faster/bigger. The computing power of your cellphone today is greater than the computing power of all computers combined in 1950. I remember my first computer having a space of 200MB, now we have virtually Tera Bytes of storage space available on the cloud. It is not science fiction if I say 10 years down the line your phone will have a Tera Byte capacity or even more.

Inflation - The prices of basic goods grows on average at an exponential rate. We all heard stories from our grand parents where they were earning a fraction of what we do and food costs was fraction of what it is today.

I want you to get a feel for Exponential Growth, wrap your heads around that fact that 10,000 years of bacterial growth is replicated in a mere second, centuries of research in computing is made obsolete in a decade.

I want to now bring this concept of Exponential Growth to personal finance. Before I start, what differentiates a wealthy person from a poor one? In my opinion it is how their wealth was created. Was it through an exponential process or was it linear.

Typical middle class or poor families earn their income primarily from their salary. Salary by definition cannot have exponential growth. Think about it, on a company's financials you are just an entry in the income statement, under operating expenses. The primary goal of a company is to make profit which is done either by increasing revenue or decreasing expenses i.e. keeping you salary as tiny as possible without affecting the revenue aspect.

For your salary to have exponential growth you have to constantly perform in your job. You have to get promoted yearly, you have to take on bigger roles, manage larger groups of people, eventually maxing out your salary at the CEO level. I can bet there is no company in the world where if you perform exactly the same as you do now, every year for the rest of your career your salary will be increased exponentially. The reality is if you don't improve constantly either your salary stays the same, or worse you will be fired and replaced by a much younger and cheaper resource.

My friends, you will never be wealthy from your job, that's a fact. You might give me counter examples of sportsperson, bankers, CEO's who have made millions in their profession. I am not denying that, I am also not discouraging you from giving your best to your work. My whole argument is, a profession will never provide Exponential Growth to your income which really creates wealth. So what does?

Investments. Your investments give you Exponential Growth. A house, a fixed deposit, stocks, bonds, your company. These will make you wealthy, not your salary.

Here is an example to illustrate my point.

Once upon a time, there were two friends Adam and Zack. At the age of 25, both joined the same company with a starting salary of $60,000. Every two years, they got an increment of 10% in their salary. Both wanted to be wealthy and both worked till they were 60.

Adam thought the surest way to be rich is to save 100% of his income till he retires. So every year, he would receive his paycheck, he would then put this money in a safe, and not spend a single cent or earn a single cent on it.

Zack on the other hand was different. He wanted to be rich too but he knew the surest way to be rich is for his income to have Exponential Growth. Every year he would save 20% of his salary and spend the rest. He would burn through 80% of his salary carefree watching movies, buying cars, travelling, much to the envy of Adam. Zack would put his 20% saving in an investment that earned 10% annually.

10 years into their career, at the age of 35 Adam was worth $830,000 while Zack was worth $260,000. At the age of 45, Adam has $2 million in the safe while Zack's investments were worth $1 million. When both of them retired at 60, Adam saved $5.4 million while Zack's saved $5.8 million.

Adam is perplexed, how could this be. How could he have had 4 times the money at one point in his career as Zack did and end up having the same amount of money as him, even though Zack spent 80% of his money every year. But the story got worse, at 70 Adam was still worth $5.4 million, while Zack's investment was $15 million. 10 years later, on their death beds, Adam passed down $5.4 million to his family, while Zack's family inherited $39 million.

Lets pause for a moment. I want you to ignore the oversimplification of this example, to ignore the hypothetical returns of Zack's investment. I want the reader to get the essence of the story, just like the bacteria in the test tube, Zack's wealth took a long time to reach Adam's wealth. But once it did, thanks to the power of exponential growth, his wealth exploded. That is what it is, a nuclear explosion (Exponential Growth in energy). Zack's wealth blew past Adam's hard earned salary based wealth. The total investment Zack made was a measly $1 million, which given enough time grew to $39 million.

No matter how hard we try, we are genetically not wired to visualize Exponential Growth. Nature has very few examples that we can relate to. Here's a test, if Zack's grand daughter inherited the $39 million at the age of 25 and never touched it while the investment continued to earn 10% annually, how much do you think it was worth when she turned 80? Any guesses ? (answer at the end of the post)

In conclusion, I hope I have driven home the point that one should not depend on their salary to become wealthy but should save and more importantly invest and make it grow Exponentially.
The more you save, the more time you give, the bigger your investment. So lets stop thinking linearly and start thinking Exponentially.




Answer:  $ 7.3 Billion (yes that a billion with a "B" on an investment of $1 million)