Once again stock markets are bouncing around. The optimists see it as an opportunity to buy – the pessimists reckon we are on the brink of another big crash.
Yes, owning shares can get a bit scary, but anybody investing in shares must understand that volatility is the price we pay for liquidity. Only shares offer the opportunity to buy and sell in small parcels with minimal cost, and have the proceeds in your account in five days.
Investment guru Warren Buffett says you should treat your share portfolio in exactly the same way as you would your real estate investments.
“Those people who can sit quietly for decades when they own a farm or apartment too often become frenetic when they are exposed to a string of stock quotations,” Buffett said. “For these investors, liquidity is transferred from the unqualified benefit it should be, to a curse.” He argues that the goal of the ordinary investor should not be to pick winners – they should simply hold a diversified portfolio and stick with it.
Buffett compared the fluctuations in the share market as akin to an erratic neighbour leaning over the fence screaming out offers for his land every day.
“Imagine a moody fellow with a farm bordering on my property who yelled out a price every day at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state … if his bid today was ridiculously low, I could buy his farm … if it was ridiculously high I could either sell to him or just go on farming.”
Let’s translate that to shares. Let’s say you owned shares in XYZ Limited, that were selling at $40. The company is highly profitable, paying increasing dividends, is well managed, and is a market leader. Suddenly Wall Street tumbles, traders world wide panic and sell, and our market drops three per cent. Of course, shares in XYZ will fall too, and you may wake up to find your $40 share is now worth $39.
As far as XYZ is concerned, nothing has changed. The business is as strong as ever, and 99.5 per cent of their investors are very happy to sit tight and enjoy the growing income stream. Only a desperate few would panic and sell and take a loss, just because the market in general reacted to events that happened thousands of miles away.
No investment offers the growth potential, ease of ownership, or tax concessions of shares. Buffett’s phrase “the curse of liquidity” sums up markets perfectly. Every investment decision you make will have advantages and disadvantages – the downside of liquidity is that you can be tempted to sell just because you can.