The stock market has a proven record of providing returns that beat inflation over time but you need to be patient and disciplined to benefit.
Shares are not lottery tickets or flickering lights on a trading screen. They represent exactly what their name suggests: percentage ownership of a company, its assets and, above all, its cash flow. You are one of the owners of the company, with all the rights, opportunities – and risks – this brings.
Public companies, those listed on the stock exchange, usually have many millions of shares available to be bought and sold by the general public. The number of shares multiplied by the value of each individual share is equal to the company’s equity market capitalisation.
Equities can be volatile and generate periods of very poor performance, however, because of a recession or a “bubble” forms in the market and then pops as stocks become too expensive. You must be prepared for volatility and actually want to embrace it: the most successful investors may buy when the market is out of favour and sell when most investors are optimistic and prices have been rising fast.
Markets represent the collective wisdom of thousands of well-informed investors, professional and private, but they are not – and cannot – always be right. As long ago as 1811, the 1st Baron Rothschild said that investors should “buy on the sound of cannons and sell on the sound of trumpets”. The legendary investor Warren Buffett declared that you should be “greedy when others are fearful and fearful when others are greedy”. If someone in the pub knows something and is telling everyone, then it is more than likely that the market is way ahead of you both.
Stock markets anticipate, or “discount”, future events. They may trade off perception and not reality and their view of the world can shape company valuations and share prices until reality intrudes as a company reports higher or lower-than-expected profits or cash flow.
One of the other great investment mantras is: if you do not understand a potential investment, do not put your money into it.