As I sat in my office Saturday evening a headline from CNBC said “Chaos on Wall St.” while another screamed “Markets in Turmoil; Special Coverage Sunday 7 p.m.”
Yes, the stock market, as measured by the Dow Jones Industrial Average, fell 3 percent one day and fell more than 10 percent from its peak. Almost 1,900 points evaporated in less than a week.
Although this may get your attention, it does not constitute “chaos” or “turmoil.” In fact, it is fairly typical for the financial markets to incur this kind of volatility.
Since 1950, the S&P 500 has had one-day declines of 3 percent or more almost 100 times. Since March 2009 the S&P 500 has fallen by 5 percent or more on 18 occasions with the average drop being 9 percent.
Furthermore, although the stock market “averages” about 9 percent to 10 percent per year the expected range for any given year should be +25 percent to -5 percent. Additionally, it is instructive to know that since 1950, the market has lost as much as 37 percent during any single year and as much as 60 percent over a two-year period. Investing in the stock market is now, and always will be, a bumpy ride.
Although investing hindsight is 20/20, it is scary at the time. Every aspect of the news media bombards us at each juncture. It is hard not to allow the mental assault to affect our decision making.
Recognizing these challenges, here are a few Warren Buffett inspired concepts that will allow you to be a better investor:
1. When you buy stock you are not trading a piece of paper. You are buying a company. Whether you buy one share or 100 shares, behave as if you own the whole company. If you owned all of Exxon or Coca-Cola, you would not day trade it.
2. The longer your holding period, the more tax-efficient your investments are. The capital gains tax is not a tax on gains, but rather a tax on trading. If you don’t need to trade, you greatly reduce your tax bite.
3. Much of the recent volatility has been created by computers with very short-term, and often irrational, trading algorithms. Just because computers can make fast, short term, trades, does not mean they are good at thinking about investing over long time frames. Don’t play the computer at its game; be a long-term thinker. You cannot out-trade the computer – so play the game you can win. Be a long-term investor.
4. Focus on predictable and consistent companies. If a business is not predictable and consistent, then how can you reasonably assess its future value? Emphasizing predictable and consistent allows a wise investor to avoid “unforced errors.”
5. The numbers in a company’s financial statements will tell you whether you are looking at a good company or a bad company. Don’t invest in bad companies.
6. Even if the numbers are good, you must still understand the business. If you don’t understand the business, walk away. There are 5,000 stocks trading in the U.S. each day and 40,000 worldwide. No one said you had to understand all of them or invest in all of them. There is no shame in saying, “I don’t know.” The older I am, the more I realize how little I know.
7. Buy above average companies at below average prices. Buying at a discount offers a “margin of safety.” This lowers your risk.
8. The news media is not there to inform you. They exist to sell advertising. Do not fall prey to their marketing misdirection or expert prognosticators. They are self-promoters looking to hype a story.
9. The stock market does not “value” businesses. Rather, it offers liquidity for publicly traded businesses. Liquidity is massively different than a fair valuation. Sometimes liquidity comes at good prices and other times at ridiculous prices. If the stock market offers you foolish prices, walk away. Let someone else be the sucker. The stock market is there to serve you – not inform you.
10. Successful investors generally spend their day reading and thinking. They are not testosterone driven ape-men who scream and shout. Avoid emotion and drama. Let logic and discipline be your guide.
Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other week.