Stocks Have At Least Some Underlying Value
There are various things you could hold as stores of value, currency for instance, or real estate, and while these things do fluctuate in value, they do have some value behind them. In the case of currency, since today’s currency is fiat money, there is no intrinsic value involved like there are with some stores of value, countries need to maintain their currency value so that in itself can represent significant value to currency holders.
Holding currency is still an investment though, with the main risks involved being losing the currency to business conditions and inflation risk. So the financial institution who holds your money needs to not lose it on you, although governments will often provide insurance coverage against this.
As currencies become inflated, they buy less, and this also needs to be taken into account. Other investments may lose value as well, or gain value, depending on the underlying circumstances, but all are going to represent various risks. Precious metals do have some intrinsic industrial value for instance, but their price may go down and you may lose significant money by holding it. All investments therefore come with some risk.
Stocks are tied to business performance, so something that delivers a certain revenue stream over time will have some intrinsic value tied to that, at least while they are profitable. The value here is therefore a temporary one, and public companies go bust as well, so there is some risk that investors may lose their entire investment if they are not careful.
In the realm of investing, one must also measure the opportunity cost of an investment, meaning investing in one thing over another, in stocks for instance instead of interest bearing accounts, bonds, gold, or what have you.
Stocks have measured up quite well over history compared to other types of investments, and have outperformed just about everything else. This is over a long period of time, which adds more certainty to this calculation, but for this to work this well it also requires a long-term commitment to the stocks, to allow for the market factors to equalize over time.
This takes the ups and downs of the market out of the equation to various degrees, with longer time frames equalizing these cycles more than shorter ones. The longer the time frame of the investment, the more relevant business conditions are, and the less relevant market conditions are.
The Two Main Drivers of Stock Prices
The role of these two factors with stocks, the business itself and the market for the stock, is something that a lot of investors don’t understand properly, although it’s central to being able to make decisions about buying and selling stocks.
If you are out to reap the benefits of a successful business that you expect will continue to be successful, by buying the stock and holding it for a period of time, the tendency is to focus too much on the business and not enough on the overall market conditions.
There are actually two separate markets which influence stock prices, which is the market for the stock itself and the influence of larger markets, such as the industry sector that it is in and the overall stock market as well.
These factors do need to be accounted for, although once again, the longer the time frame involved in holding a stock, the less relevant these factors become. Ultimately though the market does drive stocks up long term as well as short term, and the success of these long-term investments do depend in large part on a positive influx of capital into the stock market in general over time.
We have seen this in the past for the most part, because income and wealth has grown long term during most periods. Should we go through an economic depression for an extended period though, this can impact the stock market very significantly, and it’s not just because the business that you own the stock in isn’t doing as well.
People pull money out of the market during times of economic pullback, to put their money elsewhere, or even to use the money for non-investment purposes if their income declines. This will in itself depress stock prices.
Stock prices are simply a matter of the supply and demand for a stock at any given point in time, today, right now actually, and while the overall performance of the business will affect stock prices, this is only to the degree that these conditions affect the supply and demand of the stock.
So if more people are looking to sell than buy, for whatever reason, the price will go down. Conversely, if more are looking to buy than sell, the price goes up. People think this only affects stock prices in the very short term or the short term but this is how it works in any time frame.
Making the Proper Decisions While Investing
Looking at economic forecasts in the time frame that you are planning on holding a stock is therefore quite important indeed, and if for instance a long recession is predicted, one needs to factor that into their decision to buy and hold stocks over this time frame.
Not a lot of investors consider these things too much, and a lot of professional investment advice does not as well. There also may be at least some conflict of interest of sorts with some of the people dispensing investment advice, as their compensation may be tied in to how much they sell as far as stock investments go.
This is the case with brokers for sure, as this is how brokers make their money, by getting people to invest. This is how personal investment advisors make their money as well, as while they may follow a certain code, their role is to encourage investment, not discourage it, much like car salesman are encouraged to sell cars, not talk people out of buying them.
The buy and hold approach as a way to build wealth over the years through stock ownership is a very popular one among many, and there are some that claim that so few people beat the market, there’s no point in trying and holding stocks for a long time is the only sensible approach.
This isn’t necessarily the case though, and you really can’t compare multi-billion dollar funds with a lot of regulatory restrictions with an individual investor trading a much smaller account. It’s far more difficult to time the market when you have to take huge positions in things than it is with small stock positions that can be turned around in seconds.
The biggest problem by far with people using timing too much with their stock plays is that they tend to screw this up, holding when they should not, selling when they should not, and buying it back when they should not.
There is a fair bit of skill involved in you do want to make sure that you have at least a good idea of what you are doing if you’re looking to time stock plays. This can be accomplished very effectively by skillful traders, fairly decently by people who know a little about how to do this well, but quite poorly by those with very little to no idea.
Simplifying things by recommending a buy and hold strategy therefore can be a good idea indeed in many circumstances, provided people stick with it. The problem is, some people don’t, and will sell after a big loss like we saw with the 2007 recession, at the time sharper investors were buying.
When the market drives a price of a stock down too much and it’s the market that has done it, the stock becomes more valuable, not less. Without a proper understanding of how markets even work, people do make mistakes.
The biggest driver of stocks is actually credit, and as credit expands, income goes up, more people invest, and stock prices go up. Credit drives almost all of our money supply, and as it expands and contracts, the entire economy moves with it, including all stocks on stock markets.
Unless you expect the economy not to recover in the time frame you are investing in, the fact that you are seeing a contraction of money supply and money in the stock market should not be a reason in itself to bail. People should buy more during these times actually if they can if their goal is long term capital appreciation.
Overall, the stock market has proven to be a fabulous and relatively low risk way of storing and accumulating wealth, to be used in the future or left to your descendants. Benefiting from investing in stocks does require at least some understanding of it though, and it especially requires that you execute your strategies with stocks in accordance with a sound investing plan.