Overcoming Our Greatest Investing Fear

Date: May 29, 2013

Dear Reader,

Around the time of the Millennium, it was very unfashionable to own, or even consider buying, any share that was not related to telecoms, new media or technology. You almost certainly didn’t want to be seen to be keen on the consumer goods sector. Not unless you enjoyed being ridiculed.

I recently read in the Straits Times that the reason why so many people shun the stock market is because of a fear of volatility. It seems that we hate the idea of shares bobbing up and down in value. Actually, I suspect many of us don’t mind too much if the shares we own go up but we can’t stomach it when they come down.

I will be the first to admit that when I first started investing I too used to be unsettled by volatile share prices. But then one day something dawned on me. I looked at the value of a company and compared that to the previous day’s valuation. How could it be worth several hundred million dollars less in fewer than 24 hours?

What was peculiar was that nothing had changed. The company was still in business and there had been nothing in the news that could have caused several hundred million dollars to simply evaporate. What was even odder was that the very next day the few hundred million dollars that had mysteriously disappeared then re-appeared again.

Thing is, we need to remember that the stock market is an auction market where people congregate to buy and sell shares. But what’s really interesting is that the price that people are prepared to pay for shares is often a reflection of their mood rather than an understanding of the intrinsic value of the company.

So when people are confident they are prepared to bid more for shares. When they are nervous they bid less. However, it is when they are nervous that we should step in and look carefully at the merchandise on offer. Conversely, the time to take a step back is when people are overconfident. That is when they will pay over the odds, even for rubbish.

It is very contrary to think that way. But it is important to avoid following the crowd. Warren Buffett said: “Be fearful when the market is greedy, and be greedy when the market is fearful”. He also said the single greatest thing he did as an investor in his lifetime was to learn how to manage his temperament. He went onto say that he learnt how to go contrary to the essence of the day.

So when there is uncertainty and volatility you should be excited. In fact, the time to be fearful is when there is nothing left to worry about because that is when the stock market is likely to be overvalued.

So how do you overcome a fear of volatility?

My home-grown remedy is to simply forget about the price that you paid for your shares and focus instead on the present. But someone once said to me that it is not easy to forget the price that you paid for a share. So in my own case, I have a spreadsheet that details all the shares I own in my portfolio. What’s more the spreadsheet is packed full of information that will let me manage my investments. However, what are missing are the prices that I paid for the shares. I can always retrieve the data if I need to but I rarely do.

The only information I need as a long-term, buy-to-hold investor is the intrinsic value of the share, which I can work out, and the current share price. With those two pieces of information I can quickly determine whether shares are overvalued or undervalued.

Over the many years that I have been investing, I have learnt to treat volatility as an opportunity rather than a threat. But to embrace volatility it is important to appreciate what you are buying. If you don’t then you are speculator rather than an investor.

To your investing

David Kuo

This article is contributed by The Motley Fool Singapore