Do you know the allegory of Mr. Market? This useful parable—created by Warren Buffett’s mentor—might change everything you think about the stock market, its daily prices, and the endless news cycle (and blogs?!) built upon it.
The Original Mr. Market
The imaginary investor named “Mr. Market” was created by Benjamin Graham in his 1949 book The Intelligent Investor. Graham, if you’re not familiar, was the guy who taught Warren Buffett about securities analysis and value investing. Not a bad track record.
Graham asks the readers of his book to imagine that they have a business partner: a man named Mr. Market. On some days, Mr. Market arrives at work full of enthusiasm. Business is good and Mr. Market is wildly happy. So happy, in fact, that he wants to buy the reader’s share of the business.
But on other days, Mr. Market is incredibly depressed. The business has hit a bump in the road. Mr. Market will do anything to sell his own shares of the business to the reader.
Of course, the reader is always free to decline Mr. Market’s offers. And the reader certainly should feel wary of Mr. Market. After all, he is irrational, emotional, and moody. It seems he does not have good business judgement. Graham describes him as having, “incurable emotional problems.”
How can Mr. Market’s feelings fluctuate so quickly? Rather than taking an even emotional approach to business highs and lows, Mr. Market reacts strongly to the slightest bit of news.
If anything, the reader could probably find a way to take advantage of Mr. Market’s over-reactions. The reader could buy from Mr. Market when he’s feeling overly pessimistic and sell to Mr. Market when he’s feeling unjustifiably euphoric. This is one of the basic principles behind value investing.
But Mr. Market is a metaphor
Of course, Mr. Market is an imaginary investor. Yet countless readers have felt that Mr. Market acts as a perfect metaphor for the market fluctuations in the real stock market.
The stock market will come to you with a different price every day. The market will hear good news from a business and countless investors will look to buy that business’s stock. Will you sell to them? But a negative headline will send the market tumbling. Investors will sell. Please, they plead, will you buy my shares?!
Don’t like today’s price? You’ll get a new one tomorrow.
Is this any way to make rational money decisions? By buying while manic and selling while depressive? Do these daily market fluctuations relate to the true intrinsic value of the businesses they represent?
“Never buy something from someone who is out of breath”
Burton Malkiel
There’s a reason why Benjamin Graham built Mr. Market to resemble an actual manic-depressive. It’s an unfortunate affliction. And sadly, those afflicted are often untethered from reality.
The stock market is nothing more than a collection of individuals. These individuals can fall prey to the same emotional overreactions as any other human. Mr. Market acts as a representation of those people.
“In the short run, the stock market is a voting machine. Yet, in the long run, it is a weighing machine.”
Benjamin Graham
Votes are opinions, and opinions can be wrong. That’s why the market’s daily price fluctuations should not affect your long-term investing decisions. But weight is based on fact, and facts don’t lie. Over the long run, the true weight (or value) of a company will make itself apparent.
Warren Buffett’s Thoughts
Warren Buffett is on the record speaking to Berkshire Hathaway shareholders saying that Mr. Market is his favorite part of Benjamin Graham’s book.
Why? Because:
If you cannot control your emotions, you cannot control your money.
Warren Buffett
Of course, Buffett is famous for skills beyond his emotional control. I mean, the guy is 90 years old and continues his daily habits of eating McDonalds and reading six hours of business briefings. That’s fame-worthy.
But Buffett’s point is that ignoring Mr. Market is 1) difficult but 2) vitally important. Your mental behavior is just as important as your investing choices.
For example: perhaps your business instincts suggested that Amazon was a great purchase in 1999—at about $100 per share. It was assuredly overvalued at that point based on intrinsic value, but your crystal ball saw a beautiful future.
But Buffett’s real question for you would be: did you sell Amazon when the Dot Com bubble burst (and the stock fell to less than $10 per share)? Did Mr. Market’s depression affect you? Or did your belief in the company’s long-term future allow to hold on until today—when the stock sits at over $3000 per share.
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The Woefully Ignorant Sports Fan
I know about 25 different versions of this guy, so I bet you know at least one of them. I’m talking about the Woefully Ignorant Sports Fan, or WISF for short.
The WISF is a spitting image of Mr. Market.
When Lebron James has a couple bad games, the WISF confidently exclaims,
“The dude is a trash basketball player. He’s been overhyped since Day 1. I’m surprised he’s still in the starting lineup.”
Wow! That’s a pretty outrageous claim. But when Lebron wins the NBA finals and takes home another First-Team All-NBA award, the WISF changes his tune.
“I’m telling you, that’s why he’s the Greatest of All Time. The GOAT. Love him or hate him, you can’t deny he’s the King.”
To the outside observer, this kind of flip-flop removes any shred of the WISF’s credibility. And yet the WISF flip-flops constantly, consistently, and without a hint of irony. It’s simply his nature.
Now think about the WISF alongside Mr. Market. What does the WISF actually tell us about Lebron? Very little! And what does Mr. Market tell us about the true value of the companies on the stock market? Again, very little!
We should not seek truth in the loud pronouncements of an emotional judge. This is another aphorism from The Intelligent Investor book.
But I Want More Money!
Just out of curiosity, I logged into my Fidelity account in late March 2020. The COVID market was at the bottom of its tumble, and my 401(k) and Roth IRA both showed scarring.
Ouch. Tens of thousands of dollars disappeared. Years of saving and investing…poof. This is how investors lose heart. Should I sell now and save myself further losses?
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No! Absolutely not! Selling at the bottom is what Mr. Market does. It’s emotional behavior. It’s not based on rationality, not on the intrinsic values of the underlying businesses.
My pessimism quickly subsided. In fact, I began to feel silver linings. Why?
I’m still in the buying phase of my investing career. I buy via my 401(k) account every two weeks. And I buy via my Roth IRA account every month. I’ve never sold a stock. The red ticks in the image below show my two-week purchasing schedule so far in 2020.
If you’re investing for later in life, then your emotions should typically be the opposite of the market’s emotions. If the market is sad and prices are low and they want to sell…well, great! A low price for you increases your ability to profit later.
And Benjamin Graham agrees. He doesn’t think you should ignore Mr. Market altogether, but instead should do business with him only when it’s in your best interest (ooh yeah!).
“The intelligent investor shouldn’t ignore Mr. Market entirely. Instead, you should do business with him, but only to the extent that it serves your interest.”
Benjamin Graham
If you log into your investment accounts and see that your portfolio value is down, take a step back and consider what it really means. You haven’t lost any money. You don’t lock in any losses unless you sell.
The only two prices that ever matter are the price when you buy and the price when you sell.
Mr. Market in the News
If you pay close attention to the financial news, you’ll realize that it’s a mouthpiece for the emotional whims of Mr. Market. Does that include blogs, too? In some cases, absolutely. But I try to keep the Best Interest out of that fray.
For example, here are two headlines from September 29, 2020:
Just imagine if these two headlines existed in another space. “Bananas—A Healthy Snack That Prevents You From Ever Dying” vs. “Bananas—A Toxic Demon Food That Will Kill Your Family.”
The juxtaposition of these two headlines reminds me of Jason Zweig’s quote:
“The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap).”
Jason Zweig
More often than not, reality sits somewhere between unsustainable optimism and unjustified pessimism. As an investor, your most important job is to not be duped by this emotional rollercoaster.
Investing Based on Recent Performance
Out of all the questions you send me (and please keep sending them!), one of the most common is:
“Jesse – I’m deciding between investment A, investment B, and investment C. I did some research, and B has the best returns over the past three years. So I should pick B, right?”
Wonderful Readers
Great question! I’ve got a few different answers.
What is Mr. Market saying?
Let’s look at the FANG+ index. The index contains Twitter, Tesla, Apple, Facebook, Google, Netflix, Amazon, NVIDIA, and the Chinese companies Baidu and Alibaba. Wow! What an assortment of popular and well-known companies!
The recent price trend of FANG+ certainly represents that these companies are strong. The index has doubled over the past year.
Mr. Market is euphoric!
And what do we think when Mr. Market is euphoric?
How do you make money?
Another one of my favorite quotes from The Intelligent Investor is this:
“Obvious prospects for physical growth in a business do not translate into obvious profits for investors”
Benjamin Graham
You make money when a company’s stock price is undervalued compared to its prospects for physical growth. You buy low (because it’s undervalued), the company grows, the stock price increases, you sell, and boom—you’ve made a profit.
I think most people would agree that the FANG+ companies all share prospects for physical growth. But, are those companies undervalued? Alternatively, have their potentials for future growth already been accounted for in their prices?
It’s just like someone saying, “I want a Ferrari! It’s such a famous car. How could it not be a great purchase?”
The statement is incomplete. How much are you paying for the Ferrari? Is it undervalued, only selling for $10,000? Or is it overvalued, selling at $10 million? The product itself—whether a car or a company—must be judged against the price it is selling for.
Past Results Do Not Guarantee Future Performance
If investing were as simple as, “History always repeats itself,” then writing articles like this wouldn’t be worthwhile. Every investment company in the world includes a disclaimer: “Past results do not guarantee future performance.”
Before making a specific choice like “Investment B,” one should understanding the ideas of results-oriented thinking and random walks.
Farewell, Mr. Market
Mr. Market, like the real stock market, is an emotional reactionary. His daily pronouncements are often untethered from reality. Don’t let him affect you.
Instead, realize that only two of Mr. Market’s thoughts ever matter—when you buy from him and when you sell to him. Do business with him, but make sure it’s in your best interest (oh yeah!). Everything else is just noise.
If the thoughts of Benjamin Graham, Warren Buffett, and the Best Interest haven’t convinced you, just look at the financial news or consider the Woefully Ignorant Sports Fan. Rapidly changing opinions rarely reflect true reality.
Stay rational and happy investing!
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-Jesse
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I really like the comparison between Mr. Market and the WISF, well done. Both fall victim to recency bias or in sports this is the hot hand fallacy.
TPM! Thanks for chiming in. Yeah, we all know that one WISF in the friend group, at the bar, or watching the holiday football together. Every time I see a wild Wall St. headline, I think to myself, “Meh…it’s probably just some WISF who got bored of sports.” And then I carry on 🙂