Investment Risk

All investments carry risk, be they stocks (business failure), property (buildings depreciate, land can become degraded), or government bonds (inflation, low interest rates).

 In addition stocks and property are subject to market fluctuations which can be sharp, large and unpredictable. This is a fact of life, to be accepted as such if you are to invest in stocks and property.

  Risk isn’t the same as volatility. Risk is the chance of a significant or full  loss of capital from overpaying or overestimating a company’s prospects.

Price fluctuations sort themselves out over time, and intrinsic value always surfaces.   Importantly, while market price fluctuations are inevitable, remember that the dividend income paid by stocks generally stays stable and increases over time. You can live comfortably with price fluctuations if you know your dividend income is not affected. Nevertheless, you shouldn’t own stocks if a sharp decrease in their price in a short period of time would cause you acute financial or emotional distress.


Ignore the market   The stockmarket is irrelevant and a distraction. The daily changes in the stock price don’t make you richer or poorer. Only a change in the intrinsic value of the business can do that. Despite this and the fact that the stock price is the least useful information you can track, the market spends most of its time tracking stock prices.

   Once you look to the market for advice or believe the market is telling you something, you are in trouble. The market is there to serve you, not guide you.

  Warren Buffett describes the stockmarket as a manic depressive.

He treats it as a partner –Mr Market.

Some days, Mr Market is wildly optimistic and will offer you a high price for your share of the business; other days he swings to pessimism and offers to sell his share at a lowprice.

You can take advantage of Mr Market or ignore him; the worst thing is to fall under his spell.

The nice thing about Mr Market, Buffett says, is that if you ignore him, he isn’t offended and still turns up the next day with a new offer. Similarly investors should ignore the economy. The truth is that no one knows where the economy will be in one, three or five years. Consider all the worries in the last few years –the 1987 crash, the Gulf War, the Asian crisis, the Y2K bug, the tech wreck, 9/11, another Iraq war, the global financial crisis, the Euro crisis –and yet business has done well in Austyralai.  

If you had listened to the dire economic forecasters, you might never have invested and missed out on one of the greatest periods of economic and investment growth in history.   Welcome volatility.   

If you follow Buffett, you look on market fluctuations as your friend rather than an enemy and you can profit from the folly rather than participate in it.   If you have this attitude, Buffett says you have an enormousadvantage over perhaps 99 per cent of other investors.In volatile times, the market can put irrationally low prices on solid businesses. Buffett says “the sillier the market’s behaviour, the greater the opportunity for the business-like investor.”   Usecommon sense   During the technology boom Buffett refused to buy the hot, dot.com stocks that entranced everyone else. His reasoning was simple: he didn’t understand a lot of what was being claimed and he only invests “within my circle of competence” –that is, in what he knows and understands. He sticks to simple propositions.   This also involves admitting when you don’t know something.  

The investor’s chief problem –and even worst enemy –is likely to be himself.   Avoid over-stimulation from the stockmarket.

Knowing what the market did yesterdaydoesn’t help you make money –but it can hype you up.  

Investors also need to be psychologically prepared because anything can happen in the market.

Buffett’s rule of thumb is that if a 50 per cent decline in the price of your stocks would cause you severe psychological or financial stress, you shouldn’t own stocks.

  Think independently   Investors need to think for themselves to avoid the herd mentality or “group think.” Great investment opportunities come along when excellent companies are surrounded by unusual circumstances that cause investors to mid-price the stock.Remember, Buffett says, you’re neither right nor wrong because the crowd agrees or disagrees with you.

You are right because your data and reasoning are right.   Have the courage of your convictions  

If you can think rationally and independently, you then need the courage of your convictions and a willingness to act. What else does an investor need? Here’s a list: wisdom, judgment, confidence, courage, fortitude, resilience, patience, determination, intensity, energy, willpower, humility, a willingness to risk being wrong (and an ability to acknowledge this) and, equally, an ability to know when you are right –even if you are heading in a different direction to the crowd.In summary, to invest like Warren Buffett, you need to know how to value a business and how to think about the market.

And you need a business gene that knits all of the above principles together.  

 

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