Investing: Fear and Ignorance

Homilies persist because there's some truth to them. Of course, sometimes they conflict. "Out of sight out of mind." doesn't do very much to validate "Absence makes the heart grow fonder" or "Familiarity breeds contempt." Nonetheless, most well-known platitudes are grounded in the wisdom of the ages and go a long way toward expressing simple truths so they can be understood.

The one I'm taken with at the moment is "Fear is ignorance." Generally, this is true whether we're talking about the experience of a passenger on a plane to the moviegoer in a horror movie. Even the fear that afflicts our military men and women in the field would be eased to a great extent if he or she could know with some certainty what was coming next.

Livy said "We fear things in proportion to our ignorance of them." And nothing could be more germane to this observation than the attitude of the American public toward investing. Unfortunately, loss has given investing a bad name. And ignorance about investing has resulted in widespread fear about it.

Where it all began

Ever since 1792, when a bunch of guys gathered under a buttonwood tree at the foot of Wall Street and founded an industry that thrived on the transactions and not the investments, it's been all downhill. With no concern whether their clients would actually benefit from a purchase or a sale, brokers have typically earned big bucks by recommending such transations for no better reason than the commissions they made. In some cases, the reasons have been even more egregious, since the brokers—salesmen—sold shares to their clients in which their own brokerages had an interest, all the time representing their advice as unbiased and their motives pure.

Where once people invested their dollars in an enterprise, expecting to reap the rewards of success and willing to accept the risks of failure, they could and would now gamble on the foolishness and stupidity of others like themselves. They would now buy a stock with the idea of selling it to someone else for a profit with little or no consideration of the real value of what they owned that entitled them to make money on it.

If you want to test this concept, just ask any broker you know—or ask yourself, for that matter—just what it is that changes in the value of a share of stock you buy today, over the next few hours, days, weeks or months, that entitles you to make a profit on it. The obvious answer, of course, is nothing! The only thing that drives the price of that stock up or down over the short term is other folks like you who are buying and selling it and who don't know much more about it than you do.

Or, it could be the movement of the market as a whole—which is nothing more than a lot more people just like you who collectively can know even less about what makes the market move up and down.

When you stop to think of it, the only way you can hope to make money on a share of stock over the short term is to buy it from someone who thinks it's worth less than you think it is, and to then turn around and sell it to someone else who thinks it's worth more than you do. Face it! One or more participants in that pair of transactions has got to be ignorant! What do you think the odds are that you aren't one of them?

Who's the shrewd one?

And in this process, who do you think always makes money, by the way? Why it's the descendants of those guys under the buttonwood tree! They make money when anyone buys or sells that share of stock no matter who the ignorant one might be! Seems like maybe the only ignorant participants are those buying or selling in that scenario!

Early on, it was clear that the price of a share of stock could be influenced by all kinds of things that had absolutely nothing to do with the actual success of the company whose stock was for sale. It became a routine thing for someone to spread ugly rumors about a company or its industry to drive the price of a stock down just long enough to buy it, and then to spread good news about it to drive it back up again.

It wasn't until early last century that the government finally got wise to that kind of manipulation and began to legislate against it, installing a watchdog organization—the Securities and Exchange Commission (SEC)—to try to stop such shenanigans. Even with that, not all that long ago, a shrewd teenager single-handedly made about a million bucks by getting on the Internet and spreading favorable, bogus rumors about a little-known stock that he owned.

Nowadays, the natural, accepted extension of such manipulation is the salesman in the brokerage firm who "recommends" that his client buy a stock that his firm has an interest in. Or the salesman who picks up the phone and calls his client and suggests that a stock she owns "has had a pretty good ride" and it might be a good idea to sell it and buy something else that might do better for her—for no better reason than because he hasn't made any money on her account for a while.

Investing: a sure thing

No, investors earn money. They don't gamble. Investing is not speculating. It's not betting on what someone just like you—or a whole bunch of folks like you—is going to do next. No one can predict that! Investing is going back to what buying shares of stock was intended to be before the guys under the buttonwood tree turned American industry into a casino, finding they could make more money on investors than they could on investments.

Investing is picking a successful company that is capable of earning money for its shareholders. It's buying a piece of that company's action. And it's remaining a part owner of that successful business until you either need or want the money—or find that the company is no longer able to operate as successfully as you thought it could when you bought it.

Of course, you might want to swap it for some other company with a better potential should you see the price of the stock bid up so high that it no longer pays you to stay in it. In such a case, you've already made nearly as much money as you could hope to make and someone's bound to discover sooner or later that the market's paying more than it should for it.

Just look at all the successful companies out there that have grown bigger and bigger over the course of their lives. Those companies don't suffer on a day to day basis when the price of their stock goes up and down for no real reason! They just keep on doing what they do, producing the goods and services they produce, earning money for their shareholders, and paying little attention to what the folks out there are paying for their stock. If you're a part owner, you can and should do the same.

To be sure, if the company's management has started to let down its guard and becomes careless and less efficient, or because intense competition or some other unexpected business issue has severely damaged its ability to make a profit, then you will want to find another, better company in which to invest your money. But you can usually find out about those kinds of things before the price of the stock suffers as a result of it.

It would be better yet if shareholders took enough of an interest in the companies they own to demand that their boards of directors fulfill their fiduciary responsibility to protect their interests. You wouln't see these executives, like foxes in the henhouses, walking away with obscene, undeserved compensation and unconscionable golden parachutes!

Think like a business owner

When you think as a business owner—and all shareholders should—then you can enjoy the benefit of owning that business and reaping consistent rewards over time, especially if you own pieces of enough businesses not to have all your eggs in one basket. Owning stock in ten or more good companies will do that for you.

The odds are against the gamblers and very much in favor of investors. Those who do their homework can expect that, out of every five companies they invest in, one will do much better than they expect, three will do about as well, and one will probably go south. (And, despite what the professionals will tell you, it's really simple homework anyone can do.) This puts the odds at about 80 percent in your favor! And, if you bother to look at your holdings maybe 18 or 20 times in a year, you can catch those disappointments well before they do significant damage to your portfolio.

When you hear of someone losing money in the stock market, you're listening to the tale of a speculator and not an investor. Unfortunately, it is the collection of just such horror stories that keeps most people from realizing all the benefits they can from investing. It is the ignorance of what investing really is that generates such abject fear of it.

This ignorance is rampant at all levels of our society. In fact, why do you suppose there was so much resistance to "privatizing" the Social Security system—a program that would permit people to own their own retirement accounts and invest them in common stocks? It's only because those who oppose it are ignorant of what investing is really about and fear the losses that speculators usually suffer from their gambling.

Consider this: The S&P 500 is an index 500 of the most widely held US companies, chosen by Standard & Poor's for market size, liquidity, and sector representation. Dollar-wise, it represents about 80 percent of the entire US stock market. The performance of those companies, over many, many years has produced an average increase in value of around 10 percent per year. This doesn't mean that it grew 10 percent in each and every year; but it does mean that the average increase overall has been about 10% annually. Doesn't it make sense that you can do even better than that if you could pick only the best of those companies to invest in? If you do only half again as well, you will double your money every five years—a goal that's very achievable.

The Bottom Line

The bottom line is that ignorance of these facts produces the fear that keeps so many people from investing in common stocks and profiting from owning shares in American industry. It's that ignorance that keeps politicians from allowing the people who need it most from benefiting from the success of those American companies. It's that ignorance that gives American industry a bad name in the view of those who believe that "big business" is the enemy of the little guy (the guy who, by the way, might not have a job if it weren't for a successful business).

How foolish it is for those who believe that big business should be taxed more heavily to pay for their needs when so many of their needs could so easily be paid for by sharing in those profits as a stockholder!

I don't blame the little guy for being mad at some of the folks who run the big businesses and feed their own greed at the expense of their companies' shareholders. I am too! Fortunately they are the exception and not the rule. They are coming under increasing scrutiny and are being caught and rooted out. And, except in spectacular cases like Enron, they have remarkably little effect on the long-term forward progress of a business that's producing good quality goods or services for which there is a demand.

So, again, it's ignorance that blames "business" for the acts of the few who abuse their privileges. And it's that ignorance that produces the fear that keeps people from sharing in the profits that well-run companies can produce for folks in every walk of life, as shareholders.

Today, it's within the means of nearly everyone to buy shares of common stock in good companies. In fact, in the midst of this current chaos, there's a fire sale going on! Even if what you might buy should go down further, you'll be well ahead of the game when "the herd" eventually comes to its senses (which it always does) and recognizes the value of owning companies that keep on earning.

Folio brokers—brokers who allow you to invest by the dollar rather than the share—make investing possible for people who have surprisingly little to invest. One such broker charges as little as $4 for a trade with no additional fee if you make at least four trades every three months. And, because you can buy fractional shares, you could, theoretically, create a portfolio of ten stocks with only $10 (plus commission, of course). They will just spread whatever you invest over whatever stocks you want.

These brokers save money by lumping together all of their orders, and "window trading"—going to market only once or twice a day to execute the trade in bulk. The savings are passed along to their customers. This is a wonderful device for an investor but would not suit a speculating trader very well.

Of course, now that you've decided to become an investor, that shouldn't bother you at all, should it!

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EllisT

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