The Personal Finance Podcast - Why Does the Stock Market Go Up?! With Brian Feroldi

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Starting point is 00:00:52 Learn more at tellus.com slash online security. No one can prevent all cybercrime or identity theft. Conditions apply. On this episode of the personal finance podcast, we're going to talk about why the stock market goes up with Brian Faraldi. I'm your host, Andrew, founder of mastermoney.com. And today on the personal finance podcast, we're going to talk about stocks 101 with Brian Ferraldi. If you have any questions, hit me up on Instagram at Master Money Co.

Starting point is 00:01:45 And follow us on Spotify, Apple Podcast, or whatever podcast player, you listen to to this podcast tune. If you want to help out the show, leave a five-star rating and review on Apple podcast. And don't forget to check us out on YouTube as well at Master Money on YouTube. So today, we're going to be talking to Brian Ferraldi, who has an awesome book that just came out called Why Does the Stock Market Go Up? And Brian gives us some incredible insight in this episode on stock investing. And one big takeaway that I want you guys to get out of this episode is why the market moves the way that it does? Because understanding this is going to help you significantly in the long run when you start to invest. Because the biggest thing to understand an investing is you

Starting point is 00:02:30 have to control your emotions. Your emotions can create incredible problems for you if you don't control your emotions. But if you understand why the market moves the way that it does, why does it go up? Why does it go down? How is it stock created? Why do companies go public? Then you're going to have a much better chance of being able to control your emotions when the market takes a dip and understanding that if I invest for the long term, I can still build significant wealth. And not only is Brian going to give you insights on how the stock market works, but we're also going to talk through indexes and why indexes were created and why is that stock market recovered from crashes and why do companies even go public?

Starting point is 00:03:08 And how do we as investors determine what a business is worth? And should the majority of investors actually buy individual? stocks. And of course, we're also going to ask Brian what wealth means to him. So you don't want to miss this episode. This is absolutely information packed in this episodes. I want to make sure you guys don't miss this. So now let's welcome Brian to the show. So Brian, welcome to the personal finance podcast. Andrew, it is awesome to be here. Thank you for having me. So we are so excited to have you here because what we want to do today is go through investing 101. I think that's really important thing that a lot of people need to understand. And so we want to break down stocks first

Starting point is 00:03:48 and kind of go through the basics of a stock. So I want to start off by asking, what is a stock and why do they have value? Sure. A stock or a share simply represents fractional ownership of a corporation. Stocks are essentially a record keeping tool for figuring out who owns how much of a business. So let's make things simple. Let's say you and I go into business. We're going to business together, we start a very simple coffee shop. And we determine that to get this coffee shop off the ground is going to cost $100,000. Now, you and I have different amounts of money to invest. You, Mr. Moneybags, have $90,000 to put into this venture. I only have $10,000 to go into this venture. So to make the record keeping easy, what we would do is start a corporation.

Starting point is 00:04:38 we would set each stock, each share at, say, $1 to make things easy. You would put in $90,000. In turn, you would get $90,000 shares. I would put in $10,000. I would get $10,000. Add those together. We have 100,000 shares. So the entire company has 100,000 shares.

Starting point is 00:04:57 You own 90,000 or 90%. I own 10,000 or 10%. And we have an easy way to figure out who owns how much of the company. Now, that is a very simple example of why shares can be important. And when you're doing this to people, the math is pretty darn simple. It gets complicated fast when you have dozens, hundreds, thousands of people putting money into a company and they're doing so at different periods of time and at different valuations. So to simplify all of that record keeping, corporations are split up into shares. And shares are an easy way to record. owns, how much? That's a perfect and easy explanation. And I think that is one of the keys just to understanding investing as a whole. And what we've seen lately is the market is moving around a lot. A lot of people have seen maybe a dip or the market moves up drastically over a short period of time. And typically, the market goes up more than it goes down. So why does the stock market go up?

Starting point is 00:05:57 This was one of the most confusing things to me. If anybody here is loosely familiar with investing at some point, you're going to come across a long-term chart. that shows the history of stock market. So I'm based in America. The most famous stock market indices here is the S&P 500. And if you look over long periods of time, the trend is undeniably clear, right? Lower left to upper right. This thing magically, magically just goes up, up, up, up.

Starting point is 00:06:26 And while there's plenty of ups and downs along the way, the long-term trend is very clear. What you have to understand about the stock and stocks market is the stock market, and specifically to stock market indices that are tracking, those represent ownership of, in the S&P 500's case, 500 large American businesses that tend to be highly profitable, especially as a group. And at any given time, stock prices reflect two things. One, the underlying earnings power, the profits of those 500 companies. That's a small part of the value.

Starting point is 00:07:03 The second thing is how much investors are currently. willing to pay for those profits, aka how those companies are being valued. Now, the earnings of the company, the E, is fairly predictable and it tends to rise over time for a number of reasons. Is the value how much investors are willing to pay for those earnings? That's the thing that changes drastically over time. And the way that investors value companies gyrates day to day, week to week, month to month, hence why stock prices move up and down. However, over long periods of time, the way that investors value those earnings tends to even out. And it's really the underlying earnings power, the profits of the company, that tends to shine

Starting point is 00:07:47 through. And if you look over any 10, 20, 30 year history, the long term history is very clear. Corporate profits rise over time. Hence why the stock market rises over time. Absolutely. That makes complete sense. One of my favorite quotes is, the short term, the market is a voting machine. The long term, the market is a weighing machine. That kind of lies right into there. It's one of my favorite quotes overall. Now, in the last decade, we've seen the market go up a significant amount. So how often does the stock market actually go up? What's so confusing about the stock market or what's confusing to people that look at the stock market for the first time is you can check stock prices at any given time, right? You can buy a stock one second and then literally the next second the price is different. And you can tell if you're doing good or if you're doing bad.

Starting point is 00:08:33 But to really judge how well the stock market does, you really can't look day to day, week to week, month to month, or even year to year. You have to zoom out and look at long-term returns. That's how the stock market should be measured. And the good news is if you ask yourself, how often does the stock market go up? The answer is quite often. One of my favorite studies that was ever done on the S&P 500 was looking back historically over 150 years, a simple study. asked, how often did an investor make money in real terms, meaning after accounting for inflation, if they bought the S&P 500 and held for various time periods? So if you bought the S&P 500 and held for

Starting point is 00:09:19 one day, you make money about 51% of the time. So it's a coin flip over any given day where you're going to make money or lose money. If you buy and hold for a month, the odds of you making money goes up to 61% of the time. You hold for one year, it goes up to 69% of the time. Five years, 81% of the time, 10 years, 89% of the time. And my favorite stock market statistic of all is if you bought and hold the S&P 500 for 20 years, you have made money in real terms after accounting for inflation 100% of the time. So if you're going to invest in the stock market for an appropriate period of time, which to me is measured in at least periods of five years, your odds of making money are extremely good. Wow, that is an incredible stat. And the 20-year time horizon one is one

Starting point is 00:10:16 I haven't heard of where it actually goes up 100% of time. That's very interesting. So one of the things that makes people pretty nervous is when the market goes down. And we teach to keep the motions out of investing all the time here. And sometimes that's easier said than done. So maybe it's easier for folks to understand logically why the market goes down. So can you explain why the stock market crashes? Yeah. And Mike Tyson, that's a great quote here, right? Everyone has a plan until they get punched in the face. It's so easy when things are going well and calm and you're thinking about losses in theoretical terms speak. Yeah, I can handle a 20% drawdown, 30% drawdown when you actually see the dollars in your account start to disappear. It is a whole different experience.

Starting point is 00:10:59 But if you look at the long-term history of the stock market, the data is very clear. Stock market crashes occur, and they're not all that uncommon. Just within my lifetime, there have been numerous stock market crashes. So in 1987, there was a big stock market crash. 2000 and 2002, there was a big stock market crash. 2007 to 2009, there was a big stock market crash. 2007 to 2009, there was a big stock market crash. February of 2020, there was a big stock market crash. And depending on your holding period, over the last year, while the overall indices are down about 15, 20 percent from their recent highs, many individual stocks are down 50, 60,

Starting point is 00:11:38 70, even 80 percent from their highs. So depending on what kind of investments you've made, you could be going through a stock market crash right now. So the reason that stock market crashes gets back to that how, are stocks valued by investors? And there's two ways. One, earnings, the earnings power of the underlying business. That's a small part of how companies are valued. And the second way is the valuation. How much investors are willing to pay to acquire those earnings. That's a fancy way of saying how much investors value profits at any given time. Whenever there's a stock market crash,

Starting point is 00:12:14 there tends to be a widespread shift in the way that investors value the earnings of the underlying businesses. And typically, they go from being very bullish, excited to own stocks, to extremely fearful in a relatively short period of time. And if you look back historically, there's been several reasons, usually something going on in the big macro environment that causes that. And it could be war, it could be financial crisis, it could be excess speculation being washed out of the system, like in a dot-com crash, it could be the housing crisis, it could be a political assassination or terrorist attack or in 2020's case, a global pandemic. So there's usually some macro thing that starts to trigger investor sentiment changing, but it's that investor sentiment changing

Starting point is 00:13:02 that causes them to not be as willing to pay high prices for stocks, hence why stocks fall and they fall rapidly. So essentially it breaks down to there's some giant macro event and then investors' emotions get involved, and that's when it starts to trickle down into the actual market, which is very interesting. So you were actually invested during the Great Recession. So what was that experience like for you? Painful. It was very, very painful. Yeah, so I started investing in 2004. And while I didn't really know what I was doing, I was learning rapidly. And I knew enough by 2007 and 2008 to know that putting money into the stock market was a good idea, even when things were lurking bleak. So while I was as fearful as anybody during the 2008 financial crisis, I was lucky enough

Starting point is 00:13:47 or smart enough, I would guess, to continue plowing money in again, month after month, again and again and again. What's so fascinating about that is it felt terrible to do so. It just felt awful, right? I bought in August of 2008, stock market decline. I bought in September, stock market decline. But in October, stock market declined again and again and again. and it felt like I was throwing money into this money losing vortex that just eviscerated capital.

Starting point is 00:14:15 Of course, now looking backwards, some of the stocks that I bought during that time, I bought at amazing prices. And as long as you can hold throughout the entirety of the downturned, investing in downturns can be great. But I can tell you, investing through that period felt awful. Absolutely. I can't imagine how bad that actually feels when you just see your money getting cut 50%, 60%, things like that, which is absolutely probably probably. just a test to your emotions, but it also shows that your financial education helped you push through that because you knew in the long term which direction the market always goes. So lately, I've been noticing how fast things are changing at home.

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Starting point is 00:16:55 the market is that it's always recovered from those crashes historically. So why has the market always recovered from crashes? Yeah, that is another thing that just so confused me when I started out. I was like, I understand why the market was crashing in 2008, right? I mean, businesses were going under. People were defaulting. They were getting kicked out of their home. Profits were plunging. People were getting laid off left and right. It made complete sense to me. Like the economic world was falling apart. People worried it was going to be the Great Depression Part two. I totally get why stock market prices were crashing at that time. What I didn't understand is how do we get out of this? Like, why on earth will a stock market come back from this god awful time period? And more importantly,

Starting point is 00:17:38 why has it always recovered from bad time periods? And it's really when you dig into what happens during bear markets and recessions, how humanity reacts to them, that sets the stage for future growth. So this stat just blows me away. But it makes sense when you think about it. During down periods, It's during recessions, bad times force people to be far more innovative than they've ever been in good times. If you've been laid off from a job and you can't find work, that's the time when a lot of people say, okay, I'm going to start a new business because I have no other choice for myself.

Starting point is 00:18:15 Maybe they had an idea in their mind, but when things were going good, they didn't have the impetus to actually go out and start the business. Suddenly you're laid off. You're like, okay, I guess I have to start the new business. Moreover, companies are far more willing to experiment and try new business tactics in order to reduce their costs and raise our revenue. Look at 2020. I mean, how much did the business world change between January of 2020 and June of 2020? How many companies in January of 2020 allowed remote work for their employees?

Starting point is 00:18:44 5%. I don't know. How many were doing it in June of 2020? 90%. I mean, it was a drastic ship in how companies operated that was forced upon them. from tough times. The same can be said, looking back historically at all of the dark economic time periods. I mean, one quick stat in 1873, the U.S. was in a bad financial depression. And in the following decade, the phonograph, the light bulb, subways, and the telephone were all invented. That was during a terrible period economically for the country. So that's thing one. Tough times

Starting point is 00:19:18 force people to try new things and to start new businesses. Number two, during bad periods, weak businesses, the weakest of businesses out there, the pluralish run, they go belly up, right? So they cease existing. That allows the companies that are strong in their industry to capture those weak businesses customers and consolidate their market power. So strong companies outlast weak companies and they actually gain market share during downtures. That sets them up for their profits to rebound even higher after the bad time is over. Finally, whenever they go through a down, downturn period, the government realizes what's happening. And the government typically steps in to make some changes to make sure that businesses can survive. So that could include payments to

Starting point is 00:20:05 individuals like we saw during COVID. It could be loans to businesses to keep through and going. It could be stepped up government spending, broadly speaking. So when you combine all of those things together, economic downturns wash out the kind of excess and bad things about the system. and that really lays the foundation for strong businesses and new businesses to emerge, and that allows the economy and profits to rebound. As those profits start to rebound, investor confidence slowly starts to return and stock places reinflate. So that's why the stock market has always recovered from stock market crashes. And that's why, as long as those things are in place, it should always recover from crashes. That makes complete sense. And if you look at the

Starting point is 00:20:47 historically, how many companies were started in these recessions, it's absolutely absolutely amazing. And how many big companies were started during these restrictions. It's so cool to look at that's one of my favorite things to go back and see all the time. So one big thing, Brian, that we talk about on this podcast all the time, or indices or different indexes. Specifically, we talk about index funds a lot on this podcast. But can you explain what the differences between the various indexes are, specifically things like the S&P 500, maybe the Dow Jones and some others? So let's back up and rewind the clock to what are the Dow Jones Industrial Average, SP500, NASDAQ. Why do they even exist? So rewind the clock. So rewind the clock.

Starting point is 00:21:20 to the late 1800s. So at the time, stock prices were printed in the newspaper. So you would see a big table of stocks, a company name and a stock price, and that's what you saw. Well, at the time, the editor of the Wall Street Journal, his name was Charles Dow. And what he was looking for a way to do would be to take those tables of data and for him to provide some commentary to his readers so he could summarize, here's what happened in the stock market today. So to do so, to do so, So he asked his business associate, who is named Edward Jones, to come up with a solution. So what they did was they looked at the 12 largest, most publicly traded companies at the time, which were industrial companies, so chemical makers, big manufacturers, and they added up the

Starting point is 00:22:08 share price of those 12 companies. Then they divided their share price by 12. Now, when you add up a certain number and then divide by that number, that's called averaging. So Dow Jones Industrial Average was created. And for the first time, Charles Dow could report to his readers, here's what happened in the stock market today. And it was essentially a way of recording, here's what happened to the average stock in the stock market today. And they've been reporting this number ever since 1896. Now, over time, the Dow Jones caught on with investors and it became a popular metric that they could use

Starting point is 00:22:48 to judge what happened to the stock market on any given day, week, month, or year. And gradually, they expanded the list from 12 companies to 30 companies. So today includes companies like Home Depot, Apple, Pfizer. So big companies that are established today. So that's the Dow Jones Industrial Average. Well, capitalism is alive and well, and this company called Standard and Poor's saw what was happening with the Dow Jones. And they said, well, we want to create our own index.

Starting point is 00:23:17 So what Sandin Pours did is in 1957, they launched the S&P, Standard Pours, 500. Rather than only tracking 30 companies like the Dow, this would track 500 companies. And they marketed it as a more complete view of what was happening in the markets. And that makes sense because there's thousands of publicly traded companies. So measuring the market by using 30 doesn't make as much sense. Another important difference was the Dow Jones uses the share price of a company to determine how big of a factor it is and figuring out the Dow Jones price. That's not a great metric for figuring out whether a stock is important or not. The S&P 500 used what's called market cap, which is just the general size of the business.

Starting point is 00:24:06 So those two changes, 500 companies and using the market cap really made the standard and poorest 500. I would say overtake the Dow Jones Industrial Average in terms of importance. Finally, there's the NASDAQ composite. So in 1971, a brand new electronic trading system was launched called the National Association of Stock Dealer's Automated Quotations or NASDAQ. And this was the first all electronic stock exchange system. Now, that was very appealing to a lot of companies, especially tech companies, because they were selling their products to the NASDAQ to make it run.

Starting point is 00:24:43 Now, the NASDAQ has become the second largest stock market in the world, and it has 3,200 plus companies that are listed on there. But when they launched this, they wanted to create their own index for tracking what happens to the companies on the NASDAQ. Hence, why we have the NASDAQ composite. So that's what all three of those stock market indices are, but what they are at their core is there a simple number that boils down with the trading action of thousands of companies

Starting point is 00:25:09 into one number and that number can be reported and digested by investors. And that's amazing because I think that explanation just helps people understand what they're investing in the history behind that as well. So we're talking about things like the S&P 500, which has 500 plus of the largest companies out there. So why do companies like this as they start to grow choose to go public? There's a lot of companies out there that I wish would go public, but why do the ones that do choose to go public, go public? Is there a reason for that? Yes. There's typically several reasons that a company would choose to go public. from being private to being public. Let's start with the most important one. When a company is private

Starting point is 00:25:45 raising money in the private markets, oftentimes that's a company that is growing rapidly. And all companies need capital to grow. Think about like Amazon when after it was first created. They needed money for inventory. They need to hire people to make the website to ship the books, to handle customer service, to handle accounting and legal. And Jeff Bezos didn't have all the capital that he needed personally to make those investments in the company. So in order to raise capital for Amazon, he took Amazon public. Taking a company public means you create brand new shares of stock. You take those shares of stock and you list them on a public exchange. When that happens on the day that you list them, the investors that buy your stock, that money goes directly to the

Starting point is 00:26:34 company itself. So a lot of companies go public as a way to raise millions or even billions of dollars worth of capital that they can use to fund their growth. That's reason number one. Reason number two is it's typically a marketing event for a company. Some companies actually don't need the capital to go public, but by becoming a publicly traded company, they've raised their profile within the business community, and that helps them seem more legit to potential customers, and it's a big marketing event for the company. The third reason that companies go public is that when a company is private, it's stock is typically illiquid. And that just means that the investors in that company, the employees in that

Starting point is 00:27:14 company have a hard time taking their shares and selling them. There isn't really an easy way to do that. When they become a publicly traded company, a huge pool of liquidity flows into that company, and it's very easy for previous investors, insiders, and employees to sell their stock in order to monetize it. So those are the three primary reasons why companies go public. But the first one, raising capital, far the most important. Absolutely. It just helps them grow over time, which is huge for them, because that's what they're trying to do, obviously, at that point in time. So when we hear about companies going public, you have to determine an initial share price. So what is a share of stock? And how is that determined when they go public? This is a back and forth process that is really

Starting point is 00:27:56 confusing, even to me today when they figure out. So there's typically a level of negotiation between the investment banks and the company and the investment community to figure out How should we price the initial value of our company? And that's based on all kinds of formulas and ratios and current market sentiment and valuation and the company's current numbers. And that pull goes back and forward. Here's an important thing, though. The dollar price of one share is influenced by two things. One, the absolute size of the company, like the market capitalization, and two, how many shares there are outstanding. Let's go back to our coffee company example. Let's say that the fair market value of our company was $1 million, right? One million dollars. Well, we had

Starting point is 00:28:43 100,000 shares outstanding. You owned 90,000 and I owned 10,000. So quick math, our company is worth $1 million. There's 100,000 shares outstanding. Each share is worth $10 per share. That $10 per share price is kind of meaningless. It's really the total number of shares and the value of the company that has meaning. We could wake up the next day and say, you know what, instead of having 100,000 shares outstanding, let's have a million shares outstanding. While the value of our company was unchanged, it was worth a million before and a million after, so the new share price of our company would be $1, just because there's 10 times as many shares outstanding. That exact same dynamic happens with companies that go public. So it's not so much about what's the dollar price

Starting point is 00:29:31 of one share when the company goes public. It's about how much is the company worth and how many shares are outstanding that determine the dollar price of one share. Local news is in decline across Canada, and this is bad news for all of us. With less local news, noise, rumors, and misinformation fill the void, and it gets harder to separate truth from fiction.

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Starting point is 00:30:43 here and they've never invested before and they decided, hey, if the S&P 500 risk reduces overtime and I want to start investing in some of these big companies. And so they realize that that's what they need to do to combat inflation or wherever else they need to do. But to do that, we must understand what the business is worth like you're talking about with the share price. So how do we as invest determine what a business is worth? There's several ways that you can determine how a business is worth. I mean, academically, the way that you figure out what a business is worth, a business is worth, the present value of all of that company's future cash flows. That's a fancy way of saying you take the company's finances as they exist today, you project them out into infinity,

Starting point is 00:31:20 you figure out how much money the company is going to make in every single year, and then you discount those future profits by some predetermined rate, boom, you've got the current value of the business. So that's the academic answer to how much is a business work at any given time. But that assumes that you know what the company's future profits are going to be, which is impossible to know. You can guess, you can infer them, but that's just really fancy guesswork. But academically speaking, that is what the company is worth today. It's the present value of its future profits and cash flow. So that's one way you can evaluate a business. Another way to evaluate a business that's far simpler is to just with simple ratio metrics. So let's say a company, again, our company

Starting point is 00:32:04 is going to do $1 million in profits this year, $1 million in profits. How much would investors pay to own those profits? Well, let's just say they were willing to pay 10 times that number in order to get their hands on the business. So 10 times the $1 million in profits are business is now worth $10 million. Now, let's say that the next day, investors were willing to pay 15 times that number. Well, our business is now worth $15 million. So that ratio I just threw out there is called the price P to earnings E ratio. And that is a very simple financial metric that you can use to figure out what investors are currently willing to pay for a business. There's other ratios that you can use, such as the price of cash flow, price to sales, price to EBIT, price to gross

Starting point is 00:32:55 profit. In each case, what all those numbers are figuring out to do is what is the profitability of this company and how much are investors willing to pay for those profits? That determines what a business is worth. That makes complete sense. And the PE ratio is one of my favorite things to look at first just to get a glance at what the company is doing early on. So one of my favorite pieces of advice that Warren Buffett has given is that you can learn from mistakes. They just don't have to be your own mistakes. So if you were a new investor, what multi-million dollar mistakes would you try to avoid? And what are some of the biggest mistakes that you've ever had? Oh, I've made so many mistakes as an investor. I've bought stocks that have gone on to

Starting point is 00:33:31 crash. I have not bought stocks, even though I thought I should, that then went on to SOAR. I've sold stocks that then went up in value. So I've made all kinds of mistakes. But to me, the number one mistake that most people are making is they're not investing. They're just flat out not investing. That could because they are lacking the education. They don't understand why they should invest. Perhaps they don't have the funds to invest. That could because their income isn't high enough or even more common than that. Their income is okay, but they're spending 100% of their income to fund their lifestyle. So the biggest mistake that most people make is they don't pay attention to investing and they don't invest at all. Beyond that, there is one common one that I want to point out,

Starting point is 00:34:18 people that don't know much about investing, when they hear terms like IRA, 401k, and Roth, they think that those are investments. So if you say to somebody, yes, I'm invested in a Roth, it would be like, great, what do you own it in your Roth? And they're like, I don't know, what do you mean? They think that you can buy this thing called a Roth or you can buy this thing called an IRA, and that's an investment. So it's a sad case that some people faithfully put money into their IRA or their Roth IRA for many years, but they never take the second step, which was actually buying, taking that capital they put in and using it to buy an S&P 500 index fund, for example. So that's unfortunately a multi-million dollar mistake

Starting point is 00:34:58 that some people make. They fund an account, but they don't use the account funds to actually buy anything. You are absolutely right. And I actually get that question all the time. And I've talked to people who have had their funds in something like a Roth IRA or 401k and never invested it. And it's been in there for 10, 15 years, and they missed out on that compound interest over time. So it's something that absolutely happens all the time. So you've got to make sure that when you put your dollars into those accounts, you still have to invest those dollars and make sure those dollars are invested so you can reap the benefits of compound interest. And that's one of our favorite things to talk about on this podcast, Brian, is compound interest. And that's one of the

Starting point is 00:35:31 greatest wonders of the world, obviously. And it's the way to actually build wealth is to take advantage of compound interest. And one of the best ways to look at compound interest is with the rule of 72. So why is the rule of 72 such a great tool for investors? The rule of 72 is a shorthand that investors can use to figure out how long it's going to take them to double their money. So the way that it works is if you're going to make an investment in something and that investment pays a certain rate of return, you can use this rule of 72 to get a rough hand for how long you have to wait to double your money. So let's go to the S&P 500. So on an average over long periods of time, the S&P 500 has historically delivered a return of about 10% per year. So that's the rate of return

Starting point is 00:36:16 of the S&P 500. Well, if we take 72 and we divide it by the expected return of the S&P 500, 10%, we get a total of 7.2. Now, that 7.2 is the number of years that it will take us, on average, to double our money. So if that's true and we earn a 10% return, I put $10,000 into the market today. In seven and a half years, I can expect to have doubled my amount of money. And that also works for, let's say, the S&P 500 does great and it earns a 20% return. Well, 72 divided by 20, that means in about three and a half years, I will double my money. Conversely, if we have a 5% return, it's going to take over 14 years for us to double our money. So that's all the rule of 72 is. It's a shorthand that investors can use to figure out how long it's going to take for something

Starting point is 00:37:08 to double. Awesome. That's a perfect explanation. And I think that's a simple way for people to look at and figure out the compounding of their money over time. So we've talked about stocks and the basics of stocks and how they work and why they go up and down here, Brian. And we've talked about the differences between compound interest and why companies go public. So the big multimillion dollar question here is, if you're just getting started investing, should the majority of investors buy individual stocks? So I am as big of a fan of investing as there is. I just love everything about investing. And the vast majority of my personal net worth is invested in individual stocks because I really like individual stock analysis. So it might surprise you that I say that I believe that

Starting point is 00:37:49 98% of the population shouldn't bother with individual stock investing at all. That doesn't mean because I don't think they have the brain power to make the investment. It's just that from what I've seen in my life, I would say that if you take 100 people, I would say maybe 1% of or 2% of them are interested enough in investing to actually do the work that's necessary to find, analyze, vet, buy, hold everything about individual stocks. So that's the great thing about the stock market is you can have no interest in investing at all and you can still fully harness the power of the stock market by just simply dollar cost averaging into boring plain vanilla index funds.

Starting point is 00:38:33 Period. End of story. You have a very high chance of doing great over time. and you can ignore individual stocks altogether. However, if you're part of that 1% of the population that for whatever reason is really interested by business, I see nothing wrong with devoting a portion of your portfolio to individual stocks. Absolutely.

Starting point is 00:38:52 And I completely agree with that as well because it does take a significant amount of work from reading quarterly reports, digging into businesses, to understanding the business fully before you start investing into that individual stock. And in addition, you could just put your money in an index fund if you aren't willing to do that work. So that is something that we talk about all the time on this podcast. as well. So Brian, this is something that we ask all of our guests. These are a couple of questions that we kind of go through with each of our guests. So what are some of your favorite investing books

Starting point is 00:39:16 if someone wants to learn more about investing? One of my favorites, it's a bit of a hidden gem in the investing world. This is specifically for people that are interested in individual stock selection is called Warren Buffett and the interpretation of financial statements. So this book was written by Warren Buffett's former daughter-in-law who got very close to him and learned about his investing. And what it does is it goes through the three major financial statements, the income statement, the balance sheet, and the cash flow statement line by line, and it shows you the way that Warren Buffett thinks about each of those numbers. So it's a easy read and it's a wonderful primer on accounting and thinking through business advantages. So if you're in business at all,

Starting point is 00:39:59 accounting is the language of business. Even if you have no interest in picking individual stocks, I think it's a wonderful book for people to check out. Another one is called The Little Book that Builds Wealth. This book is by Pat Dorsey. Pat Dorsey is the former head of research at Morningstar, and he is like an expert on finding businesses with economic moats or competitive advantages. That's a wonderful quick read on the different types of competitive advantages that are out there and how to find them.

Starting point is 00:40:27 One other book I will throw out there. It's called 100 Baggers by Christopher Meyer. It's a broad-based study of stocks that are on the market that have delivered a 100,000, or more return for their investors and some of the characteristics that they share so that investors that are interested in finding them can find them on their own. I've read all three of those as well and they're fantastic books. We'll link them up in the show notes down below so you guys can check those out if you're interested in reading those books as well. So Brian, one big question that we ask all of our guests is what does wealth mean to you?

Starting point is 00:40:58 I love this question. It's so funny. When I first started pursuing the money and investing, all I knew about wealth is that I wanted it, right? I wanted more. of it. I wanted to see my net worth go up. And I still get plenty of enjoyment out of that. But I think the whole point of money and the whole point of wealth is for us to essentially buy ourselves the lifestyle that we want. And for me, my overall desires are fully met now. And I don't have any really big need to have a huge fancy house or a fancy car or anything like that. So wealth to me really provides myself with the ability to wake up when I want. work on what I want with who I want for as long as I want I can quit whatever I want.

Starting point is 00:41:44 I control the terms. And if I do quit, my family's lifestyle won't be impacted at all. So wealth to me is a tool that I use to live exactly the life that I want. I love that answer. And it's creation of freedom. That's the coolest thing about it. And that's what you've done and you've targeted. So I absolutely love that. So Brian, where can people learn more about you? If they want to connect with you, where can they do that as well? The most common place to connect with me, I'm on all the social platforms, but I'm most active on Twitter and YouTube. And both of those are just my name, Brian Ferraldi. Awesome. And do you want to talk about your book as well?

Starting point is 00:42:16 Yeah. So one of the things that confused me so much 20 years ago when I first started was answering that question that we started at the top of the show, which is why does the stock market go up? Yes, I understand that it magically goes up. But why is the reason that the stock market goes up and why does it always recover from crashes? If that topic interests you at all, I wrote a book called Why Does the Stock Market Go Up? And it explains all of the questions that I had about investing when I first started in a simple and straightforward as a matter that I could possibly do. Awesome. And we'll link all of those in the show notes as well. Brian, thank you so much for coming on. This is an incredible conversation. It's going to be a great resource for people when they're learning about investing and investing 101. So I truly appreciate you coming on. Andrew, thanks so much for having you. This is great. Thank you.

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The Personal Finance Podcast - Why Does the Stock Market Go Up?! With Brian Feroldi

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