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Mar 2, 2017

Top Five Investing Myths

by Theodore Tonca

Theodore ToncaSome of the more traditional ways of investing for both capital preservation and compounding purposes, such as purchasing a local family business or buying into a far larger enterprise by way of a public stock exchange to provide a continuous stream of income for years or even decades to come, have unfortunately — to the detriment of investors everywhere — not been perpetuated to quite the same extent as some of the more fabled stories presented below.

Accurately Forecasting The Future Is Necessary In Order To Be Successful

Who would have guessed that a domain typically reserved throughout the ages for self-proclaimed seers, mystics, psychics, and other colorful characters would come to be prized by a profession which likes to pride itself on rationality and objectivity.

Our modern-day equivalent of such ancient fortune tellers are economists, of whom even the most distinguished are accurate no more than once on average over the span of an entire career. Yet surprisingly (or perhaps not so much) such personages continue to be highly sought after by financial institutions for their opinions and are regularly quoted in the popular media.

Highly Complex Algebra Is Needed To Determine A Business's Underlying Value

To quote Albert Einstein, “Any fool can make things bigger, more complex, and more violent. It takes a touch of genius and a lot of courage to move in the opposite direction.” Despite such far-sighted wisdom most investment funds today continue to have their small armies of analysts compile and churn out elaborate spreadsheets filled with a plethora of mind-numbing statistics and forecasts.

Hence it should come as no surprise that the vast majority of actively managed investment funds trail the market index's year after year.*

Take a moment and think about the information you would need to make an informed, intelligent decision in order to purchase into an already operating business. First and foremost, it should probably be something within your existing wheelhouse that you intimately understand, such as a business located in your neighborhood. Secondly, you would want as much information about it as possible, up to date financial statements, ownership structure, and lastly, you would want good, quality people involved in running its operations.

Now simply take this and apply it to your research and analysis of public companies — many of which first started out as small, local businesses.

The Stock Market Is There To Guide Us

Tuning out, rather than into others’ opinions, stock charts, and signals is beneficial to your long-term financial and overall well-being.

Benjamin Graham accurately lamented that the market as we know it, exists but for one single purpose, and that is to serve us as investors rather than guide us. By providing us with recurring opportunities every now and again to purchase into businesses when prices are low and to sell when prices become dangerously high.

Unfortunately, over 600 years of exchange or “bourse”, history* has shown that people tend to do just the opposite, that is buy when prices are prohibitively high and sell when they are low.

Volatility Equals Risk

Since I do not intend for this to be an academic dissertation, I will simplify this section by saying that there is a widely ascribed to thesis going by the inauspicious name of Modern Portfolio Theory. This academic theory states that to reduce day to day fluctuations within your investment portfolio, which are deemed bad and risky, an investor should simply add un-correlated assets to the portfolio such as stocks, bonds, real estate, etc. until 'proper' diversification is achieved.

Of course, such an assertion to an enterprising investor is sheer fool-hardy, since if you are able to understand a few businesses, their underlying economics, and are able to purchase into them at reasonable prices, conventional diversification beyond a small basket of five to ten names makes no sense whatsoever. After all, what is the likelihood of anyone's 20th best idea being as good their first?

The Stock Market Is Efficient

Eugene Fama's Efficient Market Hypothesis (EMH) states that asset prices fully reflect all available information and as thus accurately represent the true underlying value of any given business.

At the end of the day, markets are nothing more than an aggregate of all individuals within a society as Friedrich Hayek established in his 1945 paper, The Use of Knowledge in Society. Therefore, a market can be no more accurate or rational than we are, which, when we take into full consideration our inherent emotions as human beings such as fear, greed, and envy among a pallet of others, is not very rational at all.

Keeping this in mind, we know that price is what we pay, but value which is what we get is another thing entirely.

 

Theodor Tonca is Chairman & CEO of Graham Theodor & Co. Ltd. A privately-held merchant banking firm originally founded in 2007.