nvesting is for the long term. There is little return in trying to “time the market” based on trends or the economic outlook. The key element focused on by the savvy investor is value. And the value of an investment vehicle is created over time.
Think about the various funds you’ve considered investing in and what matters most to you; do you go to the six-month performance or the two-year. Six months will give you a snapshot, but two years will show you historical performance.
The savvy investor considers market trends but knows that trends alone are meaningless. The same is true with the economy. While the overall economy took a huge hit in 2020 with unemployment spiking and thousands of businesses permanently shuttered because of the pandemic, the stock market seemed unfazed. The Dow and S&P 500 ended the year at record highs while the NASDAQ had its best return in 11 years.
While that might seem counterintuitive to most, it’s not unusual for the economy and the markets to trend in opposite directions. What’s more, the opposite is also possible with the economy growing during a bear market. And, as with everything, trying to predict what is going to happen and when is a fool’s errand, making value the most important factor when investing.
This is not to say that market and economic trends are not important. On the contrary, prudent investors consider them when evaluating investments, but they don’t let the two factors drive the decision. We’ve written before about chasing crowds and jumping on trends and the dangers of both (You can read about it here and here) and this is an extension of those warnings.
Institutional investors can be a good place to look for insights. When making decisions about what investment moves to make, they will “price in” how they believe the economy will affect the price of a stock. If you keep an eye on what they are doing, you will see that market trends are often a foreshadowing of economic trends. But, because economic and market movements are not correlated, all your investments should begin with value at the core.
Importance of Value
When you buy value, you are investing in a vehicle that is financially sound. As with diversification, value reduces the volatility of your portfolio by introducing investments that have an historical track record of stability. Although value investments can lose money, losses will be tempered by the strength of the investments because they are not as prone to the ups and downs of business as higher risk investments.
Determining the value of an investment varies depending on the type of investment. If you are considering the stock of an individual company, there are a variety of business metrics you can use such as price to earning ration. Investopedia created a list of some of the most popular.
Mutual funds also come in varying degrees of value, just as individual stocks, and Investopedia has another list to consider when you are evaluating investment options. Here what they have to say in the section called “Selecting what Really Matters”:
Morningstar has since introduced a new grading system. With the new rating system, the company looks at the fund’s investment strategy, the longevity of its managers, expense ratios, and other relevant factors.
The number of factors required to conduct a thorough evaluation are many, so take the time you need to identify the best value for your investment dollars.
While economic trends can have a dramatic effect on movement in the stock market, they do not move in perfect correlation. Very often, as 2021 illustrates, they will move in opposite directions. And because no one can predict the future, although many have tried, it is important to look first to the value of the investments you are considering.
Ignoring the value while following trends will end badly for you and your portfolio.