Market sentiment, short time horizons and other factors cause investors to act irrationally and, in the process, create a volatile marketplace. Staying level-headed and diligent in such an environment can yield good investing opportunities. Unable to stomach volatility, many investors decide to give up investing in public markets. These investors are choosing to sacrifice profit in exchange for lower volatility. At the time of this book’s writing, interest rates are at historical lows.
Investors Are Savvy
Investors buying Ten-Year U.S. Treasuries are accepting a yield of less than one-and-a-half percent. Rates are even lower in Germany, Japan and eight other countries. In the words of investor Whitney Tilson, “It is utter madness for long-term-oriented investors to accept such low interest rates… but institutional investors of the world are so scarred by stomach-churning volatility in the stock markets that they flee to islands of perceived safety” If there is one takeaway from this chapter it is this: volatility is not your enemy. Under the right circumstances it is your best friend! Volatility creates opportunities to buy high quality assets at irrationally low prices. Unlike in baseball where a batter has to swing at the pitches thrown, investors are free to ignore the price the market offers as many times as they please.
The opportunity to buy mispriced assets, in our opinion, is a positive. At Berkshire Hathaway’s 1997 shareholder meeting Warren Buffett spoke about volatility and Mr. Market. “…we’d probably make a lot more money if volatility was higher because it would create more mistakes in the market. Volatility is a huge plus to the real investor.” Buffett then went on to explain Benjamin Graham’s important concept of Mr. Market. Graham used the example of Mr. Market to view the stock market as business partner who tends to oscillate between mania and depression and, depending on his mood, offers a price at which he will buy or sell. “The crazier he is, the more money you’re going to make. So, as an investor, you love volatility.” Knowledge is Power The more you know about what you invest in, the easier it is to stay calm when necessary and make informed and prudent decisions.
It is important, therefore, to work hard to research and understand the value of the underlying assets you are buying. As Peter Lynch, one of Wall Street’s most accomplished investors, once said, “Investing without research is like playing poker and never looking at the cards.” This may seem rather obvious, but the truth is most investors do not understand what they are buying. Imagine the founder of a small business. The founder knows the entire history of the company, exactly how the company makes money, how much cash is available for dividends or capital expenditures, who the main competitors are and where the opportunities exist.
The founder has an excellent idea of what the company is worth. Say the founder would like to sell the business, but only at a fair price. Barring any unusual circumstances, the founder is not going to panic if he receives offers that are less than his estimate of what the company is worth. He will simply wait for an offer that he is pleased with and, at the same time, work on the next document to be translated by professionals around the office.
Investors should use the same mentality across all investment vehicles to get rid of market sentiment fears. Investing more in an asset when its price has declined sharply is not difficult if you truly understand the asset’s value. Ownership in a quality asset, purchased at a low price, will reduce the risk, or probability of permanently losing capital, of that investment.