The Question That Should Terrify Investors

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Beyond Buy-and-Hold #74

By Rob Bennett

At what price are stocks no longer worth buying?

That?s the question that should terrify Buy-and-Holders, for two reasons. One, it is a question that demands an answer. And, two, Buy-and-Holders are not able to come up with one.

Before you buy a car, you check Edmunds.com or some such site to identify the fair selling price. If you are in desperate need of a car, you might be willing to pay a bit more. But there are limits. You won?t pay $60,000 for a car that properly should go for $20,000.

Why doesn?t it work that way with stocks? Stocks were selling for three times fair value in 2000. Investors were buying like crazy. Why? Why don?t we care about getting ripped off when it comes to how we invest our retirement money?

Should ?sky?s the limit? be the rule with stocks?

Say that you think it is okay to pay three times fair value. There still has to be a limit. Would you be willing to pay six times fair value? Would you be willing to pay ten times fair value? Shouldn?t there be some price at which you would conclude that stocks are not worth buying?

People don?t even want to think about the question. It is a disturbing question. The suggestion contained in the question is that we can know when stocks are worth buying and when they are not. Which would of course be a wonderful thing. And we of course can indeed do this. So why don?t we? Thinking about that one is the disturbing part of the project.

Why don?t we want to know when stocks are worth buying?

Why don?t we want to know when we have had too much to drink? Why don?t we want to know when we have had too many candy bars? Why don?t we want to know when we have been at the gambling tables too long? Why don?t we want to know when our current flame is bad news?

We like to tell lies to ourselves. That?s why.

How stocks become overpriced

There?s only one way in which stocks can become overpriced. It happens when gains are excessive for a number of years in a row. We want to count those gains as real. It brings us closer to retirement to count the gains as real. We want.

Our minds won?t let us have what we want. Our minds are logical. Our minds tell us that the excessive gains don?t count, that they don?t bring us lasting wealth and that they don?t bring us closer to retirement. So we turn off our minds. We become Buy-and-Holders and count those excessive gains. Then they treat them as real and they depend on them.

If we all spent time thinking about at what price stocks are no longer worth buying, we all would be better investors. But there would be a price for heading down this road. We could no longer indulge our fantasies of being able to retire early by taking advantage of the phony gains we enjoy during bull markets.

The key to smart investing: facing the truth

Smart investors are honest with themselves. They always want to know where they stand. They use accurate numbers because they understand that financial planning is a sick joke when the plans are based on phony numbers. Getting the numbers right is important.

Buy-and-Holders cannot stand the thought of using accurate numbers. Using accurate numbers slows you down. Using accurate numbers means having to save all the money you need for retirement, no fudging permitted. No fair! No fun!

We all know we are kidding ourselves. I know this because of my nine years of talking these issues over with tens of thousands of middle-class investors. I have never met a Buy-and-Holder who was not defensive about his insistence on using inaccurate numbers. I have never met a Buy-and-Holder who dared to answer the question of when stocks are so overpriced as to not be worth buying.

It?s a sad situation. We do ourselves great harm by fooling ourselves. And we are all aware on some level of consciousness that that is what we are doing. But we fight efforts to get a discussion going out in the open. We prefer to live in pain over facing the struggle it would take to adopt honest investing practices.

Here?s my challenge to you: Start small. Pick one aspect of the investing project and be honest with yourself about it. If you can handle that much, I am confident you can move on to great things.

Answer the question: At what price are stocks no longer worth buying? You don?t have to answer the question in the way I would. But, if you are to claim to be a rational investor, you need to have some answer to the question.

What is it?

Are stocks worth buying when they are selling at two times fair value?

How about three times?

How about six times?

How about ten times?

At what price are stocks no longer worth buying? Do you know? Are you able to put forward any justification for not being able to advance a simple and clear and confident response to this basic question?

Rob Bennett writes about how to obtain lasting investor confidence. His bio is here.

 

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( Photo from Flickr by Helico )

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