What 99% of all people don't realize about either the stock (or similarly the
housing market) is that they are both pyramid schemes. There is no way
for the average person to make money in the housing or stock *market*.
There are plenty of ways to make money owning houses or owning stock,
but not by buying and selling them - they're pyramid schemes, and the
average person cannot make money in a pyramid scheme.

For example, imagine that there were only 100 shares of stock in
the whole world and exactly $100 willing to be invested in the stock market. In that
case, obviously the average stock price is $1. There may be some stocks
worth more than that and some worth less, but the average must be $1.
Now, if one investor pulls, say $10 out of this pool of money, there is
now $90 chasing 100 shares of stock. The average price must drop to
$0.90 per share. Or conversely, if some other poor sap comes in and
puts $10 more in, the average price must rise to $1.10 per
share. *The only way for the average stock price to increase - and
therefore, for the average person to make money buying and selling
stock - is to get more poor saps to buy in.* This is the definition
of a pyramid scheme. Some people who get in early can make money in a
pyramid scheme, but that money comes at the expense of the people who
get in late.

Now contrast that with the original purpose of stock, which was to
get dividends. The original stock transactions had nothing to do with
buying and selling stock. They were when some guy had an idea, he would
go to a bunch of rich people and basically say "If you give me the
money to start my company, I will cut you in for your share of the
profits." The rich people gave the entrepreneur money and he gave them
a piece of paper entitling them to 1 share of his profits, i.e.
dividends. I'm guessing that sometime later, one of those rich people
looked at his stack of paper entitling him to dividends and realized
that someone else might want to buy that stack of paper so that he
could then collect the dividends, thus creating the first stock
transaction. I'm guessing that sometime after *that*, someone
looked back at this transaction and noted that the rich guy actually
sold his shares for more than he paid, and said "screw this dividends
idea, I'm going to buy shares low, and sell them high", thus creating
the first stock market and the world's biggest pyramid scheme.

And note that dividends are a percentage of a company's profit,
which is definitely
not zero-sum. Profit is what you get when you make a product that has
more value than the amount of money you spent to build it. This is the
definition of wealth creation - the world is richer for you having
built your gadget. So owning stock - much like owning a house, which
has all kinds of upside (like sunrooms) - is something that the average
person *can *make money off of. Which means that people need to stop this nonsense about looking at the *value *of their portfolio and get back to looking at the amount of dividends that have been paid. We'd all be much happier.

What's always amazing is how people "double-count" the money they have in the stock market. What I mean is, imagine instead of buying some generic stock, you had a friend who came
to you and asked you for money to start a business. In exchange, he
will offer you equity in his company (i.e. a share of the profits). In
that case, you would *never *expect to see your original money
again - that money is gone for your friend to use to start the
business. What you hope for is that your share of his profits add up,
over time, to more than you loaned him (and more than you could've
gotten in, e.g. a savings account).

The logic should be exactly the same for the stock market, and yet people don't treat it that way. They expect to see the money they spent on buying stocks again. Instead, what they should be doing is only buying stock if the sum of the expected profits is greater than the purchase price of the stock (and greater by enough so as to be better than just putting it in the bank).

For example, Microsoft's P/E ratio is ~12. This means that for every $12 of purchase price, you get $1 of profit every year. This quite obviously the same as an ~8% interest rate. Let's assume that a good bank will give you 4%, but in addition, you get to keep your money (whereas we're stipulating that you don't in the stock market). After doing a little math, we find that if you buy MSFT and hold it for ~13 years, the higher interest rate (8% vs 4%) completely compensates you for the loss of your initial investment! After that, you will start to make profit - even assuming you could never sell your stock again. After 20 years, your money is 50% more than in the bank. After 30, it's 137% more. After 40 years, its 250% more.

[Side note: Try it with a few other companies - AAPL - P/E=17, after 40 years, only 70% more. GOOG - P/E=22, after 40 years, only 2% more! GE - P/E=8, after 40 years, 1000% more!]

But even this analysis is not totally right since it assumes compound growth, which is what you get if you continually reinvest your money. But if we're assuming all money invested is lost, then we shouldn't count this reinvestment as potential value either - we should count it as being used by the company we buy.

I came up with this neat graph (click for larger):

The blue curve is the amount of yearly dividends you would get with continual reinvestment of the earlier dividends after *t*
years on a $1 investment (assuming a constant P/E of 12.5). For
example, after 25 years, you would get 35 cents of dividends every
year). The red line is pretty neat - it's the amount of time it would
take to exhaust an alternative bank account. That is, if you instead
invested that $1 in a bank with 4% interest, it would grow. Then,
after *t* years, you could take an amount of money out equivalent
to the dividends you would get after that amount of time. Doing that
every year would exhaust your bank account after some amount of time.
That amount of time is the red curve.

For example, if you put $1 in a stock, after 25 years you would get
35 cents per year in dividends. You could then stop reinvesting that
and pocket that 35 cents* every year thereafter*. Alternatively, you could put the $1 in the
bank. After 25 years, it would've grown to $2.56. You could then
withdraw the same 35 cents per year (and accumulate some of that back
through interest on the rest) for 5 1/2 years before it's gone. After
that, your bank account is empty, but your stock - which we've already
assumed has lost all of its value in the stock market - continues to
pay 35 cents/year.

THIS is the power of the stock market. If everyone understood this, we wouldn't care about the value of our portfolios, because in the end, the money you put in - if you're careful - should be insignificant in relation to the profits (in the form of dividends) you get from your investment. Whether you get it back or not, if you invest in quality companies (i.e. with low P/E ratios), then you'll end up with a win.

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