By Ben Preston
“If you can keep your head when all about you are losing theirs…” So begins Rudyard Kipling’s wonderful poem If, whose message rings particularly salient in today’s stock markets. With shares in every major region experiencing declines in August, investors have been served with a timely reminder that investing is not without its risks.
During volatile times, it can be hard to avoid being swept up in the emotion of the moment, but resisting that impulse is critical. Warren Buffett cannily advises investors to “be fearful when others are greedy, and be greedy when others are fearful.” Simpler advice is to set those emotions aside entirely, and focus on what really matters.
Investments on the stock market are ownership stakes in real companies, not just lines wiggling up and down on a price chart. Thinking like a long term business owner is key, as it helps investors avoid falling into the trap of overreacting to short term noise.
Most families’ largest investment is their home. It would be immediately recognised as the height of folly to knee-jerk into selling one’s home every time a crack appears in the paintwork, or the Bank of England threatens to adjust bank borrowing rates by some small fraction of a percent, or some far-off country reports a slower rate of economic growth than economists expected. If it would be foolish for homeowners to behave so skittishly, why should it be any smarter for business owners?
For equity investors, the most important determinant of long term returns is the relationship between a company’s share price and its fair value. A company’s true value doesn’t typically change much from day to day, but its share price can fluctuate wildly as investor sentiment swings unpredictably from optimism to pessimism. For investors with a genuinely long term time horizon, the occasional stock market panic is no bad thing. Indiscriminate selling pushes down prices, allowing long term investors to lock in higher rates of return than were previously available.
If that’s good news for returns, what about risk? Are stock markets any riskier during turbulent times? No. At least, not for the long term investor. While the perception of risk may be more acute during periods of volatility, the underlying risk profile has not worsened. If anything, it may have improved.
That’s because the true risk in investing cannot be measured by volatility, or any other complicated mathematical construction. The true risk in investing is rather more prosaic – losing money – which is typically a result of overpaying for shares in the first place. All else being equal, lower share prices give investors fewer chances to overpay.
Recent price falls in stock market averages should not come as a major surprise; investors with a time horizon shorter than several years should be aware that further losses certainly cannot be ruled out. We have observed for some time that overall stock market prices have been high relative to historical norms – an unfortunate environment for anybody looking to lock in attractive returns at moderate risk. But for the genuine long term investor, counterintuitively, a lower stock market is no reason to panic, and is actually a welcome development. “If you can wait, and not be tired by waiting…” then building a well-chosen portfolio of shares in good companies trading below their long term worth is sound investment advice whatever the economic climate.
Ben Preston is an equity analyst and director at Orbis Investment Advisory
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