How a Volatile Stock Market Turns Investors into Gamblers
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Don’t let this wave of stock-market volatility go to your head. The value of the companies in your portfolio doesn’t change by a positive or negative 5% three times a day. Get the value right and the price will follow.
For example, my firm recently met with a prospective client, a physicist who has made millions of dollars by owning apartment buildings in the U.S. and Canada. He confessed that he never was able to make much money in stocks. As we talked to him we observed why. The Dow was having one of those 500-points up and 500-points down days. He was visibly happier when the Dow was going up and sadder as it was going down.
People who are otherwise successful as businessmen and as investors in private businesses or real estate change their behavior completely when they enter the stock market. I have a friend whose father has made hundreds of millions of dollars by building several companies from scratch in Mexico. An absolutely brilliant businessman – and the worst stock investor ever. He’d fret about every move in his stock portfolio.
As we talked to the physicist we used this analogy: What we (or any rational investor) do is not much different from buying an apartment building. First you look at the quality – how well the building is built, the location and demographic trends in the area, and so on. Then you start valuing this building. You formulate your best-case and worst-case scenarios for rents, occupancy, property taxes, and other important variables – price to square-foot, price-per-bedroom, price to worst-case rent. In the stock market these shortcuts are price to earnings, price to cash-flows, price to book-value.