Four Keys For Peace of Mind – Part 2 of 4

Key 2: The Mr. Market Parable

In the opening of this chapter, I introduced you to Benjamin Graham and his book, The Intelligent Investor, which was published in 1949. At the heart of the book is what he called the Mr. Market parable.

Graham asked readers to think of the market quotations that are offered every day for individual stock prices, bond prices, mutual funds and so on, all those quotations, as being generated by a single man. His name is Mr. Market.And the unfortunate thing about him is that he’s a manic depressive.

So some days he’s pumped with optimism and he’s going to offer higher and higher prices. Other days, sometimes for no good reason, he’s downtrodden, pessimistic, and he’s just going to offer lower and lower prices.

The point Graham made for investors with his parable is this: Mr. Market is there to serve you rather than to pressure you. If he’s going to sell you stocks at cheap prices, it’s on you to take advantage of them by buying. If he’s going to offer to buy stocks at ultra-high prices, you should take advantage of them by selling.

What happens if you let Mr. Market pressure you?

Here’s a way to think about that in the context of what, for many middle Americans, is their largest investment in terms of equity: their home. Let’s say we’re talking about you, and you believe your home is worth $500,000. Imagine Mr. Market knocking on your front door one day and saying, “Hi, I’d like to buy your home for $500,000.” You say, “Thanks, but we really like our home, so we’re going to have to decline and keep our house.”

The next day there’s another knock, knock, knock. “Hi,” Mr. Market says, “I’d like to buy your home. And today, since you declined my offer yesterday, I’d like to offer $400,000.” “No,” you answer, “I still really like my home, and I’m not going to sell.”

But in the back of your mind, you’re now thinking, Well, the location isn’t perfect and there was a burglary down the road last month. Maybe my home isn’t worth as much.

Next day, knock, knock, knock. “Hi! I’d like to buy your home for $250,000.”

Now the feeling is getting worse and you worry that the offers will just keep going lower. You think, “I don’t want to wait until it’s only worth $100,000. At least I could get out now for $250,000.” And you sell your home for $250,000.

You might say that’s silly, I would never sell my home just because I was getting offered lower and lower prices. And yet people sell their stock holdings under these psychological circumstances all the time. When prices start falling, people start feeling like they’re losing money, and it hurts. They stop believing their investment will make money over time and start believing it will lose money. They want the pain to go away, so they end up taking real losses in order to avoid larger potential losses.

The Presidential election in 2016 demonstrated this effect. The night of that election, the Dow futures dropped seven hundred points, which meant the market on the morning after would open substantially down from where it had been before. That spooked a number of people, including one of my clients, Tom, who thought he saw chaos coming and got out of the market altogether. I’m not arguing politics one way or another here; I’m talking about loss aversion, about fear. When you consider what the market did after that day, it’s clear. Tom missed out on the gains to come.

When it comes to your portfolio, it can be a challenge to stand apart from the crowd and the emotions of the moment. I think bearing the Mr. Market parable is important. It helps you keep the market price of the moment in perspective. And you’re less likely to feel the pressure of running with the crowd when negative emotions take hold.