The Stock Market Is Not There To Instruct You. It’s There To Serve You…If You’ll Let It

My phone has been ringing off the hook lately…

And my email inbox is bursting at the seams as well.

The stock market is gyrating more than Elvis Presley in a 1950s beach movie and everyone keeps asking me the same question…

Are we about to enter another big, scary recession like 2008-2009?

Given the recent significant declines in stocks, people are starting to make comparisons to the dark days of the Great Recession. And those were indeed some dark days.

And with dark days in the market, comes the inevitable question for investors – should you sell?

The problem with this question is its context.

As the world’s greatest investor, Warren Buffett, has said: “The stock market is not there to instruct you. Rather, it’s there to serve you.”

In other words, the movements in the market shouldn’t be telling you how to invest.

Because the market, for all its glory, is a lousy instructor…

-When Wells Fargo fell under $15 per share in 2009, the market was teaching that all banks were going to fail and that you shouldn’t invest in them.

-When Proctor and Gamble hit $47 in 2009, the market was announcing that the world would no longer need Pampers.

-When Coke tumbled to $20 in 2009, the market proclaimed that nobody would drink another Coke.

But in all these cases, the market was wrong. Dead wrong.

As I wrote a couple weeks ago, the market is volatile. It gyrates. That’s normal.

Therefore you shouldn’t be surprised when people panic in the market. That’s normal too.
However, the key for successful investing is to know what to do when people panic in the market.

A thorough understanding of how investors’ minds work is essential if one is to figure out where a market is in its cycle, why, and what to do about it. For me, the markets’ recent behavior reinforces that observation.

So, instead of listening to the market, I seek to take advantage of it. Sometimes, the market will offer an opportunity to buy a stock for far more than it’s actually worth. Other times, it’ll offer you the chance to buy shares of a great company for far less than its fair value.  An investor who understands the true value of a business will be able to profit when the market offers great companies on sale.

However, to be able to think like this requires the investor to transcend what most everyone else in the market is thinking. And making this payoff requires a great deal of patience and discipline.

You see, most market participants are always worried about something. Today it’s the falling price of oil; additional slowing in China; worsening news from the Middle East; and continuing uncertainty regarding the Fed’s future action on interest rates.

It’s the job of the intelligent investor to strike a proper balance between offense and defense, and between being mindful about losing money and ensuring that you don’t miss opportunity.

Hence, an investor does not buy or sell a “movement” and should not be affected by the ups and downs of the market. A sound investor buys a well-managed business, with strong earnings growth and significant barriers to entry that will provide long-term security. Someone who reacts to “movement” is nothing but a speculator; a purchaser of solid businesses with sound fundamentals is an investor.

Buffet sums this up nicely with this quote…

“49 colleges and universities visited Omaha this year. If I ran a business school there would be only 2 courses. How to value a business and How to think about markets. No modern portfolio theory, no beta, etc. You don’t have to be right on 4000 or 400 businesses, not even 40. Circle of competence. Start with a small circle and slowly expand. Don’t spend time on companies that don’t lend themselves to valuation. Accounting is useful, but sometimes it is not meaningful. Durability of competitive advantage is the key. And market fluctuations. The market is there to serve you, not instruct you. If you are an investor and you have a 150 IQ, sell 30 points to somebody else. Being a genius can be a bad thing in this business. You need an inner peace with your decisions, because they will be challenged. I don’t know how much of that is innate and how much is taught, but it is a very good quality to have. Simple but not easy. No higher math. It’s not complicated. But you need an emotional stability. If you have that you’ll do well over time.”

If you’ve read thus far and you’re still saying, “Yeah, but….”, I have a thought for you.

Maybe your not cut-out for stock investing. That’s not a criticism. Most people aren’t cut out for it. They just don’t have the right emotional stability as Buffett says. Stock picking is not a hobby. Everyone can be an investor, but I’m not convinced that everyone should be an investor. To be a successful investor requires thousands of hours of deliberate effortful study to master the necessary skills, and also something equally important – the right temperament.

It’s human nature to be emotional, and there are many areas in life were emotions are important. But know this – emotions kill investment returns. Many people make systematic errors in their investment thinking, due to their emotions, egos and innate cognitive biases. Their emotions betray them – they think about risk more when things are already going badly in the market and less when prices are up. And when things start to go very bad, they look for answers in all the wrong places – namely what everyone else is currently doing.

If you would like an example of what to do when the market gyrates wildly, look no further than Warren Buffett. He’s a paragon of rationality. His investment decisions are insulated from emotions. He thinks long term and so he doesn’t panic when the market falls; instead, he sees market drops as buying opportunities. To invest better, I encourage you to become a student of human psychology. Learn how emotions lead to cognitive errors, so that you can avoid those errors and benefit when others make them. This is key to winning in the stock market.

Ben Graham (Buffett’s mentor) had a great analogy. Imagine the stock market is a person, Mr. Market, who’s willing and able to buy any stock from you or sell any stock to you on any given day. Mr. Market is sometimes rational and the prices he sets are often reasonable, but occasionally he gets very emotional or irrational and the prices swing wildly in one direction or the other. When he’s rational and offers no great deals, you are free to ignore him. (Hence the importance of patience.) When he’s greedy, you can sell to him at a premium. And when he’s fearful, you can buy from him at a discount.

Don’t underestimate him, but also don’t look to him for guidance about the actual value of things and what to do next. In other words, don’t seek instruction from him. Instead, look to him for opportunities to serve you.

Be free. Nothing else is worth it.

Financial Freedom Monty Campbell

Looking for other ways to be be a better investor? Check-out these other articles from the blog archives:

7 Mistakes That Kill The Small Investor’s Odds Of Being Successful In The Stock Market

Want Better Investment Returns? Aim For Average

Can The Experts Really Predict The Stock Market? The Answer May Surprise Some