The single most important question on most investor’s minds is a simple one: Will things get worse?
The honest answer is that nobody knows. Yet how far the stock market declines might not matter much if you have no immediate plans to sell. You might even prefer to buy.
Warren Buffett explained this dynamic using the metaphor of hamburger meat. Nobody complains when ground beef is marked down, he said. Everyone complains when stocks are on sale.
Buffett put it this way in a letter to his shareholders way back in 1977:
A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall.
In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
The logic here is hard to dismiss. Why would you want to pay more for something if you could pay less?
Stocks are no different from any other purchase. You want to get them more cheaply. But they are different in the sense that nobody buys a car expecting to sell it for more money in the future.
Some people do when they bid on collectible vehicles. But most of us just try to strike the best deal, avoid the worst of that initial depreciation and hope that the maintenance and repair expenses don’t eat us alive.
Stocks in that sense are really different from hamburger meat by the pound or a new car. We absolutely expect stocks to rise in value and to sell those holdings at that higher value at some point in the future.
Even more reason to pay as little as possible for stock in the first place. So how do you avoid paying too much?
One way is to invest steadily over many years. Another is by diversifying, that is, by owning many different stocks. That way you reduce the risk of losing money if one company or another goes under.
If you buy stock steadily over decades it’s very hard to lose money. But you can lose money if you own too much stock as near retirement. That’s why advisors strongly suggest a steady move toward bonds as you get older.
Like in Buffett’s hamburger example, anyone who expects to sell their stock today or in the next month or so has good reason to find the recent market declines upsetting.
If you had no such plans and no immediate reason to sell the current price is much less relevant to you. Rather, locking in a paper loss by selling at a low might in fact be something you come to regret in time.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.