Tuesday, January 27, 2009

Did You Really Lose?

Some of the conversations you hear nowadays are fascinating. Sitting in a Second Cup earlier this week, I heard someone at a nearby table mention that they had lost $20,000 in the markets. Their friend chimed in with a similar story. As I sat there enjoying my caramelo coffee (if you have never tried it, you don't know what you are missing), I wondered what the real truth was behind their stories. It also made me reflect on the "stories" I have heard of late.

A young man who started investing about seven years ago recently stated that he had lost 30% on his investments. I asked him was that 30% of the contributions or the highest value. He said based on the last six months. When we actually looked at the numbers, he came to realize that in fact he had only lost most of the growth on his deposits. His original deposits were still intact. As we continued our discussions, I pointed out an fact that was obvious to me, but had escaped his attention.

People often say that "if we had sold our home" at it's peak, they would have gotten more money. Here is the simple math - you purchased a home for $300,000 - it later escalated in value to $450,000 (or so you believe). You did not sell. Now values in your area have dropped and the home is worth $400,000. For some reason, people mistakenly believe that they have "lost" $50,000. It could not be further from the truth. Gains and losses are only created if you sell the home. Your home is now worth $400,000 a gain of $100,000. If the same rules applied to both your home and your investments, then in theory you should sell your home before it drops in value any more.

It seems like everyone has a great memory when it comes to bad things but forget the good. I believe that is the influence of today's media. News that isn't negative, is not worth printing or reporting. If you want to stay safe and invest in cash, Canada Savings Bonds and such, that's fine. You can sleep at night and know your investments will be there tomorrow. The only problem - historically those investments have been outperformed many times over by people who invested in stocks and equity funds. MARKETS ALWAYS GO UP AND DOWN. If they only went up, then no one would invest in anything but the markets.

Let's hop aboard our time machine and go back to the early 1980's. Your aunt passed away and left you $10,000. A friend suggested that the Toronto Stock Market was doing great and you invested it all. From June 1981 to June 1982 your investment dropped in value to $6,180. How you reacted at that point ultimately determined your future. Why? Over the next 12 months, the TSX rose by 86.9%. Your original $10,000 was now worth $11,550.

While it is certainly frustrating to see your savings value drop, the harsh reality is that bailing now means selling at a loss. The mantra of buy low and sell high makes perfect sense. However, being a contrarian goes against human nature - we like to do what when everyone else does. The herd mentality has given us many great things - Nortel Networks is a great example. I love to quote Warren Buffett for two reasons - his long time success in the market and his results. Here are a couple examples of his philosophy on the markets.

- For some reason, people take their cues from price action rather than from values. What doesn't work is when you start doing things that you don't understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it's going up.
- Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.

No comments: