When Mr. Market Offers You A Deal, Take It

by MB on January 9, 2008

“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.” – Warren Buffett in the 2004 Berkshire Hathaway Letter to Shareholders

I heard something very interesting on CNBC last night: 2008 has been the worst beginning for stock markets ever. That’s right, according to CNBC, stocks have never declined more through the first eight days of a new year than in 2008.

Through January 8, 2008, the Dow is down 211.77, or -7.98%, the S&P 500 is down 78.17, or -5.32%, and the NASDAQ is down 211.77, or -7.98%.

I have found the writings of Warren Buffett to be invaluable in my education as an investor over the years. He doesn’t look at stocks as pieces of paper to be traded, he sees the underlying proportional ownership of a business that the stock represents. As long as you have a good feeling about the prospects of the business, you should welcome declines in the price as an opportunity to buy more of a good thing at a better price.

To illustrate his point, Buffett included this story of “Mr. Market” in his 1987, Berkshire Hathaway Letter to Shareholders:

Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic- depressive his behavior, the better for you.

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.

Please pay special attention to that last paragraph. If you can’t reasonably form an opinion of value on a company, you have no business owning it’s stock. Buying shares in Google, because you think they will go up is not investing, it’s speculating. I’m not saying the speculation is a sinful practice, but you should never confuse it with investing.

That being said, when broad sell offs occur, they provide excellent opportunities to add money to index funds. Over time, even with recessions, American business will grow. You are better off if you can purchase that growth at a better price. By that logic, you should hope for extended bear markets while you are investing your capital, and a great bull market as you sell stocks and rotate into fixed income securities for retirement.

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