Countless financially conservative individuals say that investing in the stock market is nothing more than a crapshoot. Still, others who have lost money in stocks often lament the fact that the stock market is a gamble they wished they had never taken.
With so much fear and negative sentiment, it often begs the question – are stocks just luck?
Stocks are not just luck. While there is an element of luck involved in any type of future speculation, the proper research, foresight, diversification, and patience can make stocks a winning proposition for everybody, most of the time.
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The “most of the time” cannot be emphasized heavily enough.
While the stock market has historically generated very favorable returns for investors, there are periodic downturns (bear markets) in which portfolio balances inevitably drop. Therefore, bad timing on the part of day traders or other short-term investors can yield some bad luck, as markets need time to correct themselves in a positive direction.
Are Stocks a Form of Gambling?
As there are some elements of luck involved in stock investing—most of which center around entering or exiting the market at the right or wrong time—many people equate stocks with gambling. They see the person who got rich by being an early investor in Amazon as no different than the person who hit the jackpot playing slot machines.
However, stocks and gambling differ in a very important way: When playing the lottery or casino games, an adversarial relationship is formed. Either you win, or the house wins. It is a zero-sum affair where no wealth is created.
With stocks, the money you front is used to help the enterprise in which you invest. When the company wins, you win. Wealth is created, and everyone “playing the game” is happy.
It is also important to note that it is possible to lose everything when gambling or in a stock investment. However, while gambling gains are capped by the odds at which you wager, stock market returns are potentially limitless, as being an early investor in a future mega-cap stock can yield life-changing returns.
Do Stocks Require Luck?
It would be remiss to say that there is no luck involved in the stock market. Luck plays a part in all facets of our lives. There is usually an element of luck involved in a person landing his or her dream job or meeting his or her significant other. Stocks are no different than this.
However, rather than focusing on luck, it is better to think in terms of risk and reward when dealing with the stock market.
Those people who are willing to take on more risk in their investments will likely be viewed as lucky or unlucky as time passes, as the potential reward for risky investments is great. At the same time, the chance of loss is similarly significant.
On the flip side, those who are more risk-averse will likely never end up feeling particularly lucky or unlucky, as they will likely stay away from anything that could ever go bankrupt but lacks the upside to make them rich.
The following breakdown looks at how luck will factor in for various types of stocks:
Small Cap Stocks
Small-cap stocks are typically those that have recently issued public shares and have a market capitalization of $2 billion or less. Market capitalization refers to the total value of all outstanding shares of stock.
Some common characteristics of small-cap stocks include:
- Usually involve companies that have outgrown the scope of private funding but are still not well-known to the public yet
- Will commonly have 100 or fewer employees
- Leaders in industries that have yet to take foot
- Shares are usually inexpensive compared to larger-cap stocks
Small-cap stocks require public funding to help grow their enterprise. Because they are not well-established, there is a significant risk in investing in small-cap stocks. Some things that could go wrong include:
- Their industry never takes off
- They don’t know how to run a successful business
- They are not equipped to handle growth
Investors are often lured to small cap stocks because they are affordable. If things go right for the business, then those who took a chance early will be handsomely rewarded and seen as “lucky.” If the business goes bust, those who invested will feel unlucky.
In general, there needs to be quite a bit go right in order for a small-cap stock to explode. – The Amazon and Netflix stories are exceptionally rare.
Therefore, it is vital to do thorough research before investing in small-cap stocks and realize that too much money directed at the wrong small-cap stock could all disappear.
Medium Cap Stocks
While the figures vary among publications, most agree that medium-cap stocks are those with a market capitalization between $2 and $80 billion. These are typically the hot stocks that the FOMO crowd loves to speculate on. Some characteristics of medium-cap stocks include:
- Companies that are viewed as disruptive in a hot industry
- Relatively new companies that have likely been publicly traded for less than ten years
- Fierce competition from other companies that are trying to recreate what they do
- Rising share prices, usually approaching or exceeding $100 per share, depending on the number of shares outstanding
- Companies that may or may not be profitable, with executives focused on how to deploy accumulating resources for most effective growth
When dealing with medium-cap stocks, there is still plenty of room for upside. The danger lies in the hype being more powerful than the substance of the company.
Stocks issued by well-run medium-cap companies can definitely have ten times the future upside. However, there will be many investors in medium-cap companies who got in at the end of the hype train and feel frustrated that their investment flatlines in the years to come.
Large Cap Stocks
Large-cap stocks are household names that have market capitalizations above $100 billion. They are the Amazon, Apple, Netflix, Costco, Wal-Marts of the world.
At this stage of maturity, it is highly unlikely that anyone will still get “lucky” investing in these companies. Their days of explosive growth are likely in the past.
Conversely, it is also extremely unlikely to get “unlucky” investing in these companies, as they are essentially too big to fail. One of the only real threats is that government regulation would force them to alter their business practices.
In addition to their stability, large-cap stocks typically offer a dividend (but not always), which is a quarterly payment that investors can count on. When these dividends are factored into the modest, steady growth that these companies will likely continue to see, investors will usually be looking at a comfortable return on their investment each year.
How to Get Luck to Work in Your Favor with Stocks
As you can see, there are various levels of risk involved when investing in these three market capitalization tiers. Depending on your personal preference, you may like what you see from any of the three.
However, if you want to give yourself the best chance of gains with the lowest possible risks, consider the following points:
- Diversify Your Investments – Make sure your portfolio contains a mixture of small, medium, and large-cap stocks.
- Do Your Research – Make sure you understand what the company does and how it is being managed before you back it with investment dollars.
- Be Patient – Stocks take time to perform. They may go lower after one week, one month, or even one year. However, if you hold your position for a solid 5-10 years, it is extremely unlikely that you won’t see some sort of ROI – as long as you made a solid investment.
Due to the roller coaster ride of gains and losses and fortunes made and lost in the stock market, many people erroneously believe that stocks are nothing more than luck.
While there is an element of luck involved in any future speculation, stocks are far more than just a shot in the dark. the stock market can generate massive amounts of wealth for anybody who is willing to do their proper research, diversify their investments and be patient.
And there you have it. To everyone who read this article, thank you – I truly hope you found the information that you were looking for here today, and as always – remember to make the most of your money.