The financial world is a confusing place at the best of times. But with the current uncertainty in markets there may be a particular need for clear thinking. It is possible that we are already in a bear market but no one can know for sure. The difficulty with bear markets is that by the time one realises one is underway, it can be too late to sell.
"We have no choice but to sit tight, knowing deep down that we’ll reach our destination"
Yet the natural reaction at times like these is to raise cash and put it under the mattress, for fear that the world is about to fall apart. But the world never really falls apart, and the best course of action can be to stand firm and be brave. To help you in this endeavour, here are some simple thoughts about investing.
Volatility is not something to fear, but something to embrace
Why do we fear stock market volatility so much? As an airplane’s wings must bend during turbulence to prevent them from snapping, so too must shares fluctuate, sometimes gently, other times wildly. Of course, severe turbulence during a flight can be an uncomfortable experience but we have no choice but to sit tight, knowing deep down that we’ll reach our destination. But in the world of investing there is little to stop us bailing out at the slightest wobble as our emotions get the better of us. Try then to welcome volatility. Shares do not go up without it.
Think long term
All stock price movements are a combination of unpredictable noise on the one hand and the meaningful pattern of business performance on the other. Over short periods price movements are as good as random, while over long ones business performance dominates. As an investor, you should align your time horizons accordingly. If a factory, for example, is expected to provide at least ten years of returns, so should your shares.
Know the difference between gambling and investing
We all like to have fun once in a while. A trip to the casino is an excuse for a good time but approach the stock market in the same way and you’ll quickly find yourself in trouble. Successful investing is hard and often dull, requiring discipline and lots of study. For that adrenaline rush, few things beat watching the roulette wheel spinning. When it comes to making good investment returns, however, owning the casino itself tends to be more profitable than entering it. Think about it.
Be contrarian
We have a tendency to do or believe something just because others do. It makes us feel normal, part of the group. Occasionally, however, such behaviour is counterproductive and even dangerous. Rush for the exit in a crowded market with everyone else and you risk getting trampled. The same applies to behaviour in the stock market. Selling – or buying – behind everyone else is a sure formula for poor investment performance. Warren Buffett teaches us to “be fearful when others are greedy and greedy only when others are fearful.”1
Consider the difference between price and value
In the real world, the distinction between price and value is frequently apparent. Given the choice between a $10,000 car and a $10,000 tee shirt, it’s pretty clear that the car is better value. In the investing world however, it is much harder to discern the difference. Unlike a car, whose economic utility is something we can understand and even evaluate, the value of a company is somewhat intangible and thus a tricky concept to grasp. Guru stock picker Philip Fisher noted that the stock market is filled with individuals who know the price of everything, but the value of nothing.2
Be humble, the stock market is smarter than you
Overconfidence might help to secure a job promotion or the attention of others at a nightclub, but in the investing world, an over-inflated opinion of yourself can be disastrous. You may think that you are in a position to predict the direction of the market or a particular stock over the next few months but remember that there are millions of others doing the same thing. Apply a little humility and ask yourself honestly whether you are really smarter than all of them. As the father of modern economics and successful investor John Maynard Keynes noted, “Successful investing is anticipating the anticipations of others.”3
Avoid things you do not understand
The world is an increasingly complex place and one often finds oneself blinded by science or confused by complicated arguments. With investing, it is important to understand precisely what you are buying, at least so that you can sleep soundly at night. Think about shares as you would a book: if you don’t understand it, put it down. Peter Lynch recommended that if you cannot summarise in just a few sentences why you’re investing in a company, then you’re probably looking at too much information.4
And finally…
If you place bets proportional to their market odds on every horse in a race, you’ll come out slightly down, after the track’s take. This is a pointless strategy, particularly if you know more than others about horses. It is important to understand where you have an edge and, when you have one, to use it to your full advantage. We never forget Buffett’s tip, “Wide diversification is only required when investors do not understand what they are doing.”5
1 Warren Buffett, Chairman’s letter (2004) to shareholders
2 Philip A. Fisher, Common Stocks and Uncommon Profits (1958)
3 Isms (2006) by Gregory Bergman
4 Morgan Housel, Keep It Simple, Fool (2008)
5 James Altucher, Trade Like Warren Buffett (2005)
Published in Aberdeen marketing
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.