by Scott Pape - October 15th 2005
I’ve resigned myself to the fact that there are two things I’ll never fully understand – relationships and the stock market.
There’s a reason for this – neither of these fickle beasts behaves rationally. Relationships by their very nature are driven by love and loss and the stock market is little different. Almost all short-term investors are motivated by greed and fear.
We all know that a fair amount of “liquidity” helps start (and end) many relationships. The same goes for shares. But liquidity – allowing shares to be bought and sold quickly – is one of the key benefits the share market has over other investments.
It also means that prices are quoted continuously.
Emotional influence
The irony is it’s these advantages that often cause knee-jerk reactions from investors. This was reinforced last week as the stock market turned sour, suffering its biggest one-week slump since the terrorist attacks of September 11, 2001.
The underlying value of businesses that make up the share market doesn’t change radically from day to day. Short-term movements in the share market have more to do with emotion than logic.
Moreover, both novices and experienced investors are influenced by what I call the dissemination of financial porn.
Who knows what the future holds
Everyone wants to know what tomorrow’s hot stock will be – today. Millions of minds across the globe spend millions of hours trawling through the financial tea leaves in an attempt to predict the future.
Some argue that the stock market is going higher due to the opportunities unfolding with the rapid rise of China. Others say the billions of dollars that pour into financial markets each week via compulsory superannuation will send stocks higher. Then there are those that argue the exact opposite, citing the high price of oil and household debt as factors that may kill the economy and take the share market with it.
Wanting an answer to these important questions, clients often ask me where I think the stock market is heading. Luckily, I have a scientific formula that has proved to be just as effective as other market experts’ predictions. I explain to clients that if they’re wearing blue undies the market is heading higher, if they’re red it’s probably going lower, and if they’re not wearing any I start to get a little nervous.
Consistently inconsistent
William Sherden in his book The Fortune Sellers points out that market experts failed to predict many milestone events, including the stock market crash of 1929 and the recession of the 1980s. They even consistently failed to pick the direction of interest rates and of the market as a whole.
In reality, there are simply too many variables to consider to be consistently right. So let’s forget the tarot cards and the crystal balls and focus on what is known.
Historically, owning a share in a business has delivered the best returns for investors. When you think about it, how could it not be? If there was more money to be made owning a building than running a business – why would anyone start a business?
Most of us have been in the situation where we have thought: “the people who own this business must be making a killing”. Perhaps it’s when you read your credit card bill and look at the interest you’re charged, or when you go to a party and see the sea of VB cans.
Opportunity knocks
Through the share market you have the ability to invest in these very companies.
While the day-to-day movements of these companies’ share prices are held to ransom by the emotions of millions of investors, over the long term share prices ultimately reflect the value of the profits the company makes.
Sound advice
Perhaps we can learn a lesson from billionaire Warren Buffett – arguably the best investor in the world – whose favourite holding period for a stock is “forever”. Buffett counsels investors to “stop trying to predict the direction of the stock market, the economy, and interest rates”.
The share market fell 3 per cent last week, which simultaneously triggered newspaper headlines and ulcers for many investors. But let’s take a reality check and keep it real: the stock market has gone up 70 per cent since March 2003.
In fact, if you had placed a lump sum of $10,000 into a fund that tracked the index in January 1990 it would now be worth $51,248 – a return of 10 per cent each year.
As with relationships, sometimes it’s best to pay less attention to the short-term bumps and instead focus on longer-term profitability. According to Buffett “the share market represents the transfer of money from the impatient to the patient”.
Remember, after every stock market crash, shares have never failed to hit new highs.
Tread your own path!
Photo: http://www.flickr.com/photos/kraetzsche/3820338564/
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