Sir Francis Bacon is attributed with the quote “Knowledge is Power”, but it is ironic that he died nearly destitute and in disgrace for corruption. So I would like to humbly suggest changing his philosophy to:
Prudent use of knowledge is power…
Knowledge applied aimlessly is foolishness…
Lack of knowledge is laziness.
Which are you? Powerful? Foolish? or Lazy? I am not trying to be patronizing. I ask myself this question almost on a daily basis. Why? Because I believe that we all have a responsibility to be as informed as possible, in order to make sound decisions that will ultimately shape the life we lead.
When it comes to finances, the world is complicated. I do not consider myself financially astute and understand firsthand how hard it is to maneuver through the jungle of investing in stocks. I don’t have a degree in finance or an MBA. All I can say is that I have studied this intently for the past few years and have come to some startling discoveries.
I am posting this for your information in the hopes that you will find it useful as you use it to become powerfully in control of your investment decisions.
- The London Exchange can trace its history back to 1698 when its founder – John Castaing – began to organize the market in Jonathan’s Coffee house via a simple list of stock and commodity prices. The New York Stock Exchange was founded in 1792 by 24 Brokers with the signing of the buttonwood agreement. The following cartoon illustrates conceptually what the stock market does.
- How and why people buy stocks has changed over the years, directly impacting the way a stock behaves. If we take the cartoon at face value, you buy a stock because you feel that the company will pay you dividends when it is profitable. If the anticipated dividend meets or exceeds the rate of return you can get in another investment, it makes sense to buy the stock. Is this how the market behaves today? No!
Let’s take Google as an example. Google is one of the poster children of stocks. It has traded as high as $600/share. To give you an average return of 5% on your investment it would have to pay out $30/share to its shareholders. Google has NEVER paid out a dividend AND according to Google Execs, it NEVER will!. So, why should you buy the stock. This is not even speculation! They will NEVER pay out a dividend – yet the stock is still valued. The only reason Google has value, is that people who have no clue as to what they are doing – buy the stock. It is pure gambling. Yes granted, Google is sexy – Google makes cool things but this is important for you to understand…
The underlying value of a stock has very little to do with how it trades!
- What does this mean to you as an investor? As you put money into mutual funds, 401ks and the stock market, you are gambling with your money AND paying people to gamble it for you. The main reason the stock market has gone up over the past 30 years, is that people poured money into it. Now, using the herd mentality, you could argue that it is what it is. That if the herd is making it go up, where else could you have put your money over the past 30 years and made as much money. One could argue real estate, but my answer will surprise you. You had your money in the right place, but you weren’t managing it properly.
- Still not sure that this makes sense? Another example that is repeated time after time, day after day on the stock market. A company’s stock is trading at $50 on Monday. After the market closes on Monday, it releases its earnings for the last quarter. The news is good. Record earnings and solid profits. Great news if the stock behaves like those in the cartoon you just watched. Reality – the stock tanks 30% overnight and on Tuesday morning it is now selling for $35/share. Within 6 months the stock is back at $50 and for those of you who are long term investors, you shrug your shoulders and wait for it to appreciate to $52.50 by years end, an increase of 5%. Someone just make a killing and the investor got 5%. The investment bankers made well over 60% (30% down, 30% up) using the investors money, while the investor got 5%. Why…. because most of us are lazy. We are not using the knowledge that is out there to take control of our financial future.
If the underlying value of a stock has little to do with how it trades, how do you place a value on your investment. This is what drove the market into a tailspin. The cat is out of the bag, and bankers are having a hard time placing a value on their investment vehicles. What does this mean? I cannot predict the future. I try not to be a doomsayer. However…. take note… knowledge is power… if used prudently…
Start following the news and watch how China reacts to the US crisis. Why? Because they were a large reason why our economy soared the last 10 years. They are the major holder of our debt with about 30% of outstanding treasury bills. This past week, Chinese officials began to express concern that the US may not be able to meet its debt obligations. The fact that we spent $2 Trillion in our attempt to save the financial system is not giving them a warm fuzzy.
IF (and it is an IF) China decides to decouple the Yuan from the dollar and IF it decides to take its money elsewhere (this won’t happen overnight… but beware the fable of the frog in the boiling water), then investors in US stocks will be wondering why the market went down 50% below what it is today. Can’t happen you say? How do you know if we can’t place a value on a stock?
What to do? Get educated. Learn how to actively trade your own stocks and stop relying on others to do it for you. Anyone could have made money in the market over the past 30 years. The question really is, who is going to make financially sound decisions in the next 30 years. Is it you? Prudent use of knowledge is power!
All the best!
All the time!