One of the ways to become a great investor is to have the ability to keep your head and stay invested during times of bad news and bear markets while others around you might be panicking. We all know this is true, but because we are human, it is easier said than done.
We can become better investors by understanding that whether news is good or bad, what matters most if it is better or worse than expected.
Imagine that you’ve been not-so-subtly suggesting birthday gift ideas to your significant other, family, or close friend. Finally, your birthday comes and goes, and while those close to you were kind enough to recognize your big day in other ways, you don’t get the gift you want. Most of us would probably be somewhat disappointed. Although you may have received something nice for your birthday, it’s not what you wanted or expected.
In a way, the millions of investors in the stock market collectively act like the hopeful gift recipient.
Publicly traded companies are required to disclose the details of their finances and profits on periodic financial statements that let investors know if management is hitting their goals, cutting costs, increasing their profits, etc. When these profits, or simply “earnings”, are released, they are immediately compared to the estimates for how other investors thought they were going to do.
If the earnings that are released were exactly as expected, we would expect the stock price to stay the same. In the scenario of the birthday gift, we got exactly what we wanted and we are content. Alternatively, if there were a surprise in the financial statements we would expect the stock price to increase or decrease sharply. Investors in the market did not get the gift that they wanted and will react accordingly.
There are many different ways that expectations affect global investing. To name a few, there are expectations for when the Federal Reserve could raise interest rates, for what the inflation rate will be 2 years from now, for what the unemployment rate could be next month, and for volatility. These expectations are used as different variables to determine what the short-term stock price of a company should be. When, in reality, one of these estimates is different from the expectation, the stock price will move to reflect the new information.
As long-term investors, we should aim to look past the sharp volatility that may come when new information is released that is different from what we expected. If a profitable company misses their expected profits, but is still a growing and profitable company, it is probably still a good investment. When volatility happens, we need to evaluate whether it truly influences our long-term goals, otherwise we risk making long-term decisions on short-term information.
Submitted by Sterling Retirement Resources, Inc. on November 12th, 2015