There are some very basic things about investing that few people ever seem to fully grasp.  The most obvious is that investing at low prices is better than investing at high prices.  I should be able to end this piece here and let you figure out the implications, but since they seem so little understood I feel compelled to explain some.

We go shopping at Costco not because we like walking on concrete floors or because pushing big carts is good exercise or even because the free food samples about dinner time are compelling enough to overcome the quarter mile walk in and out to the car.  It’s because the prices are low.  Wal Mart and Target have similarly grown into huge companies because, and I’m unveiling a special secret now, their prices are low.  It seems that we free market shoppers are really good at finding good values everywhere in our life except when it comes to investing.

When investments have had a  very strong run prices are necessarily much higher than they were at the beginning of the period.  And yet that is just when investors get so excited about buying them they can’t wait to get in line for more.  Like a kid in a Tiffany store.  In fact, the higher investment prices go the more investors want to buy!  Now imagine Costco marking up prices two or three fold.  How long would you keep shopping there?

On the other hand, imagine what it would be like if Costco promoted a 50% off sale on everything in the store.  There would be lines for miles outside of each location.  But when investments hold a 50% off sale everyone runs for the exits, hoping that someday the high prices will be back so they can get buying again!

It seems to me that we have a simple underlying belief that investments are either good or bad by how much money they made the previous owner.  When in fact, like with the retailer, it is possible that the relationship might even be the inverse of that.  A fat profit margin for the previous owner might be a good indicator of a bad purchase for us.

Remember that when you make an investment you are buying a series of cash flows; a fancy way of saying that you expect to get some more money back tomorrow.  The less you pay for that future sum of money the better off you are, right?  If that’s too complicated, remember the Costco analogy and celebrate lower prices as a great opportunity to get a good deal, instead of deciding that falling prices are a reason to be depressed and stop investing altogether as most people do.

 

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