If you haven't heard the investing parable of Mr Market, today is a great time to correct that injustice. It's a story first told by legendary investor Benjamin Graham, but popularised by his even more legendary disciple, Warren Buffett.
In this parable, Graham describes the nature of a personified stock market (Mr Market) and how investors should take advantage of it without falling for the traps that it sets out for us.
Here's some of how Warren Buffett laid it out back in 1987:
Without fail, Mr Market appears daily and names a price at which he will either buy your interest or sell you his. Even though the business that the two of you own may have economic characteristics that are stable, Mr Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems…
Under these conditions, the more manic-depressive his behavior, the better for you. But… Mr Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.
By "falling under his influence", Buffett refers to the tendency that some investors have to take the prices the stock market gives us to heart.
Many investors become terrified when they see shares of a company they own plunge in value. This might even prompt them to sell those shares for a huge loss, just to avoid the pain of seeing them fall even further in value.
Similarly, investors can also let greed get the better of them. Seeing a stock euphorically rocket higher can prompt a feeling of acute 'fear of missing out' and elicit someone to buy the now expensive shares when they probably wouldn't have done so before.
As Buffett says, falling for these traps is often "disastrous".
Image source: Getty Images
'Mr Market' is there to serve, not guide
That's also the view of renowned AMP chief economist Dr Shane Oliver. In a recent edition of 'Oliver's Insights', Oliver points to Warren Buffett's warning, "Remember that the stock market is a manic depressive", as a key insight to keep in mind in the current environment.
Here's some more of what he told ASX investors:
Rules of logic often don't apply in investment markets. The well-known advocate of value investing, Benjamin Graham, coined the term 'Mr Market' (in 1949) as a metaphor to explain the share market.
Sometimes Mr Market sets sensible share prices based on economic and business developments. At other times he is emotionally unstable, swinging from euphoria to pessimism. But not only is Mr Market highly unstable, he is also highly seductive – sucking investors in during the good times with dreams of riches and spitting them out during the bad times when all hope seems lost.
Investors need to recognise this.
Similarly, Oliver also quotes the influential economist John Maynard Keynes' advice that "Markets can remain irrational longer than you can remain solvent".
Oliver warns investors that you can't rely on personal predictions of what Mr Market will, or should, do at any point. Making huge bets that may ruin your finances if wrong is not a good way to go about investing.
It just goes to show how important sticking to timeless principles of success like diversification, apathy towards what others are doing, and long-term thinking is in today's modern world.
