Know What You Own and Own What You Know

As I write, greed and euphoria have finally developed into the gambling mentality now permeating the stock markets in the US. History shows us that this will end in tears.

The secret of success in long-term investing, as distinct from making speculative short-term bets, is avoiding serious permanent loss. The saddest chapters in the long history of investing speak of investors who were motivated by greed or simply tried too hard. All too often, leverage (borrowing to buy more stock) is a weapon of self-destruction. When deciding a long-term strategy, investors should differentiate between ‘maximisation’ and ‘optimisation’. Among the maximisers is Icarus of Greek mythology, who tried to fly to the sun. His fate was sealed by hubris, and he crashed and burned. As investors, focusing on what we know and not on what we cannot know saves us from being hoisted on our own petards.

In these irrational times of sharply increasing stock prices, understanding yourself, your priorities and your investment goals is the best shield against the temptation to short-term action motivated by greed or the fear of missing out. Do not trust yourself to be completely rational when the noise of the market is overwhelming. Having a carefully thought-out investment strategy and committing it to paper is essential to avoid the traps and hype.

In his classic, The Intelligent Investor, Benjamin Graham divides the stock market into two imaginary characters, ‘Mr Market’ and ‘Mr Value’. Mr Market is a deceiver, a tempter crying ‘Buy me! Sell me!’ while Mr Value just plods along ignoring all the noise, secure in the knowledge that he has value irrespective of the price for which he may be selling in the market. Rather than paying undue attention to the market, you should focus on the value of what you have.

We may reason that our long-term interests are best served by lower prices, so we can all buy more cheaply. However, who really delights when market prices fall dramatically, and who is not delighted when rising prices lift portfolio values? This scenario means that stocks are more expensive and that future returns will be lower. When prices fall in the stock market, we stop buying, and when they rise sharply, we tend to buy. Unless we know what we own and why we own it, we will sell at the first pang of loss. In fact, many are now speculating in the stock market simply because they can. We are wrong when we feel good about stocks having gone up in price and we are equally wrong when we feel bad about stocks going down. If we shopped for stocks the way we shop for socks, we would be better off!

Markets are made up of people and reflect human endeavour and ambition. A falling market is necessary in order to buy at a lower price and sell at a higher price later. Being tempted by Mr Market in the hope that a greater fool will buy an already expensive stock is not a recipe to achieve optimum investment outcomes over the long term. After all, the market can remain irrational longer than you can remain solvent!