I was recently told by a friend that she had bought Apple stock in March of this year, at $200 a share, and later sold it for $300 a share, making a profit of 50% in 8 short months. I asked her how much she bought and she said 10 shares (for a total cost of $2,000, which was all she could afford). In other words, she earned a profit of $1,000. Not too shabby you might say.
For those of you who have been readers for some time, you might know that we tend not to advise anyone to buy stock. This has much to do with seeing markets as efficient, and much to do with the fact that, much like gambling in a casino, individual investors will almost always lose out to the bigger, entrenched market players. “But look at your friend, who made a profit of %50 in less than a year!” you might say. And you might continue with: “And if she had more money available to invest, say 10 times as much, she would now be sitting on a profit of $10,000!”.
So let us break down this transaction. First of all, when she bought 2000 shares my friend had to pay commission. Commissions can range from 5% to 33% in general, with mutual funds charging an average of 20%. Let’s be generous and say she only paid 10% commission. Even with low commissions, however, there are many fees that the brokers will tack on, such as IRA fees, paper statement fees, electronic statement fees, exchange fees, odd lot stock fees and withdrawal and deposit fees. However let’s assume these fees totalled no more than 2%. In other words:
10% + 2% of $2,000 = $240
So, a net profit of $760, correct? Still not too shabby. But don’t forget that taxes are paid on stock. These are called capital gains taxes and, since the stock was held less than a year, they will equal the income tax. My friend happens to fall into the 25% tax bracket. Therefore:
25% of $760 = $190.
$760 – $190 = $540 Profit
If we had gone with the $10,000 example, your profit would have been $5,092, since we’d have to place you in a different tax bracket.
So, after all is said and done your profit $540, right? Well, sort of. The crux of the problem is not that fees, taxes and commissions come in, which are easy to calculate, but everything else.
My friend, assuming she did buy Apple at the low and sell it at the high, would have made $540 (or 27% profit) on Apple. But she neglected to mention how her other investments were going. Sadly, although the S&P 500 has earned an average of over 10% in the past 20 years, the average investor has earned a paltry 1.87%. This, simply put, is because when an investor hears about a good stock, she will buy it, and when bad news comes out, she will sell. In other words, she will buy high and sell low, always several steps behind the curve.
So, a more accurate assessment might be to ask how much, total, money was used for investing, and how much, total, was taken out when all is said at done. I’m sure if I asked that of my friend I’d have a very different picture. Even this, however, does not show us all present factors.
When you want to invest in stock, it helps to research various brokerage houses or websites, to read up about investment strategies, keep up to date with the market on a daily basis, if not more, and talk to various friends and colleagues about their investments. You may also want to buy various books by Jim Kramer or Michael Lewis or Warren Buffett or Maria Bartiromo. All of this is before even researching the specific stocks to invest in (not all of which you’ll end up buying). In other words, for every stock an investor invests in, there are about 100 hours of research put in. Now, not to sound too cliché, but time does equal money. The time spent on investments could have been spent on your job, your well-being, on making money via other venues, etc. So, how much is your time worth? Even if we give it a (well) below average value of $20 per hour, this means $2000 spent on each stock. In other words, each stock should earn $2000 just to break even.*
In summary, therefore, I’d advise not to invest in stock. Even judging by the 1.87% average return, you’d have to factor in commissions, taxes, fees, as well as all the time that could have been spent on making a profit by other means, or just playing outside with your kids.
* I include this last statistic at the end, not because I think it is less significant – in fact, since it the most often overlooked portion, it is likely to be more significant than the others – but only because as far as I can tell, no studies have been performed on how many hours research is spent per stock. Investors talk of 6-7 hours for every stock they are seriously considering, but this doesn’t take into account all the background research, such as watching tickers and CNBC and reading journals and books and talking to friends and colleagues. 100 hours seemed very much on the low end, but if anyone has any other numbers I’d be happy to hear them.