Markets are interesting beasts. In a sense, they are purest form of capitalism, a space where all that matters is transactions.
According to investment researchers, the sheer mass of buying and selling going on in our capital markets means that prices reflect, all the time, the actual value of the underlying companies.
People take issue with that idea, and I understand why. Stocks sometimes are bid way down or way up, depending on the emotions of shareholders. That’s a powerful force.
It’s also an utterly unpredictable one. There’s no reason a stock you bought has to go up or a stock you hold can’t continue to go down. You might disagree with the direction of your holdings, but the fact remains that prices are set by others.
And that, in the simplest, non-mathematical terms, is what Modern Portfolio Theory is all about. Prices are accurate because there is no alternative universe in which the valuation of a company is different from the minute-to-minute tick of its stock price.
You can be given stock, perhaps, as compensation, or earn it through a company program. You might inherit it free of taxes. You could, potentially, trade stock in one firm for shares in another, as companies sometimes do in order to merge.
But if you have to buy or sell in an exchange, the price is the price at the moment you decide to get in or out, end of story. Whatever happens next won’t change the price you paid, and that price was in fact the “value” of the company at that moment in time.
So how to do what all investors want to do, which is to buy low and sell high? It’s disarmingly easy.
First, own a portfolio of investments, one which includes stocks, bonds, real estate, commodities and foreign equities and debt.
Next, make sure the portfolio accurately reflects your ability to withstand the ups and downs of the markets. You don’t want to be scared out of an investment for no reason.
Finally, let the market does it’s magic. As some assets rise in value, you sell off a portion of them to buy those that have declined.
You can keep track by measuring the percentages: If you expect to be 60% stocks and 40% bonds, but the balance right now is more like 65/35, you sell the extra in stocks and buy bonds till you’re back in a 60/40 balance.
That’s selling high and buying low, automatically, and it’s the path to a better, more reliable long-term return.