Financial Education – The Real Danger of Buying Stocks and Etfs

Some of the most popular communities on Facebook regarding Financial Education are promoting the strategy called Buy & Hold. When people first get into this space the first and easy solution is to do what Warren Buffet does and that is to buy value, keep it for a long time and sell. That’s it, there is no exit strategy. You buy and hold until it’s time to sell. The thing people forget to mention is when and why to sell. Because of this lack of clarity and direction this strategy should be called Buy & Hope.

US stocks have been in a bull market for several decades. All the attention is now concentrated on them. They have become very popular in the US mostly because everybody is indirectly involved through their retirement funds. 

FAAMG is 20%

ETFs are viewed as the safest investment option. The largest ETF in the world is called S&P 500 and it trades on the NYSE under the symbol name SPY. The top 5 stocks colloquially called FAAMG (Facebook, Apple, Amazon, Microsoft, Google) have a weight of 20% in the index. The ETF direction is clearly dependent on these stocks’ performance.  

ETFs remove losers

The S&P 500 is also creating the impression that the direction is predominantly up over a long period of time. The ETF components are dynamic and they favour the stocks that are doing well. The stocks removed would not make such a visual pleasing up trending chart.

Equal vs Cap Weighted

SPY is a cap-weighted index, it assigns the largest weight to the stock with largest market value. RSP is a equal-weight index that applies the same weight to all of its components. In a very strong bull market it’s natural SPY will outperform RSP by a certain factor. People prefer strong stocks so most of the investments cluster around the top strong assets. In theory a single group of stocks could be the driver for very strong SPY while the RSP could stay in a range. This kind of divergence is not yet visible on the long term charts but it one of the many possibilities of the future.

Shorting is hard

Shorting is presented by many as a great alternative to long only. But most of them forget to mention that statistically, short strategies are performing badly over the long run especially on stocks, it’s hard to implement and has extra costs associated with borrowing of the shorted assets.

US Stocks are in a bubble

The bubble will pop eventually. There is enough evidence in the past to determine that US stocks are in a bubble and eventually the bubble will burst. The hard part is to predict when this will happen and how severe and prolonged the bear market will be. This trend could continue for months, years or decades. There is no way of telling. The only high probability fact is it will happen in the future and this probability must be taken into account and not completely ignored.

Recency bias

In general humans have a short memory span. If a trader starts his career in a bull market, that keeps going for several years, his personal bias will be that the stock markets always go up. Even if the graphs over the long run show great correction of even 50% this is being a considered just an unfortunate past event that has almost no probability of repeating itself.

‘The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.’

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