Reality Check: What is Stock and Why Own it?
With billions of dollars exchanging hands each day, continual fluctuations in prices, and constant media chatter about the “market”, it’s easy to lose sight of what we are actually purchasing when we buy publicly-traded stocks. Let’s try to remember: we are buying equity stakes in businesses. When compared to bonds, real estate, gold, or other investments, the value of stocks seems to almost appear out of thin air. This is because human beings imagine, plan, and build companies using their unique creativity. These companies, when successful, increase in value at a much greater clip than other investments whose values are closely bound to scarcity or the laws of supply and demand.
This is why the growth rate of the stock market is often times compared to the increase in value over time of fine works of art. A talented artist on canvas creates something of great value out of nothing just like a team of brilliant engineers creates computer chips out of sand. Over the long run, other investments lag because they lack this creative component.
The modern stock market allows any and all of us to participate in the potential return that creative and talented people can generate within publicly-traded companies. However; because the number of buyers, sellers, and transactions is so mind-boggling, it completely changes the risk dynamics. We cannot buy stocks the way we buy other investments. It is critical to diversify away risk that is specific to a single position because the extremely high volume of trading disallows us from reaping any benefit from the price at which it was bought.
Note: Modern Portfolio Theory (MPT) supports the previous sentence, which deserves more explanation than can reasonably be provided in the context of this post. Contact me if you want more information or have questions on systematic vs. unsystematic risk or the efficient market hypothesis (EMH).
Crazy as it sounds, this ends up being a good thing for long-term investors. In a fully diversified portfolio, we can reap the benefits of stock appreciation over time, as long as we can accept the volatility that comes with being invested in an extremely efficient marketplace. Information flows and prices change at a pace that can only be measured in milliseconds. As long-term diversified investors, we choose not to participate in the arbitrage and daily trading that occurs in order to reap the benefits of the market efficiencies they help create.
Stocks are uniquely suited to the needs of long term investors when properly used. The massive financial services and media industry that surrounds the market is a testament to its importance and potential, but also exacerbates our efforts. Registered Investment Advisors, like our firm, help cut through the noise and shrouds of disinformation to help investors achieve their long term goals. To discuss further, contact us so we can assist you.
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