When evaluating investments, look at value over price
Published 12:00 am Sunday, February 7, 2010
Most investors pay a great deal of attention to the price of their investments — yesterday’s price, today’s price, tomorrow’s price, next year’s price and so on. And that’s understandable, because we always want the prices of our investments to rise. Yet, if you focus too much on prices, you could end up making some costly mistakes.
Why? Because price-driven behavior is emotional behavior — and as an investor, you’re much better off making decisions with your head, not your heart. Suppose, for example, that you’ve seen a steep decline in the price of one of your investments. After a while, you may feel that you just can’t take it anymore and you decide to “cut your losses” by selling the investment. Conversely, you may have an investment that has gone up and up — and to grab even bigger gains, you buy more shares.
Both these decisions could backfire on you. When you sold the investment whose price had fallen, you might find yourself on the investment “sidelines” if that same investment starts to turn around. And when you throw more money at an investment whose price has skyrocketed, you’re betting against history — because no investment goes up forever. Furthermore, in both cases, your emotions will have led you to violate one of the guidelines of investing: buy low and sell high.
But apart from the tactical errors you may make when you over-concentrate on price movements, you’re also ignoring another key characteristic of investments — their value.
Traditionally, an investment’s “value” has been largely defined as whether or not it’s considered “expensive” or “cheap.” That’s why many investors take a close look at a stock’s price-to-earnings ratio. Generally speaking, a high P/E means a stock is more expensive, relative to its earnings, than a stock with a low P/E. Investors may be willing to pay more for the high P/E stocks because they feel these companies will be worth more in the future.
But P/E doesn’t tell the whole story of investment value. Any individual investment may have value to you because it can help you diversify your holdings. And while diversification, by itself, can’t guarantee a profit or protect against a loss, it can help you reduce the effects of volatility on your portfolio. For instance, if your portfolio is heavy with stocks, the presence of some bonds — even those whose market price has fallen because interest rates have risen — can help reduce the impact of a downturn that primarily affects stocks.
Clearly, the value of any investment has several dimensions — any or all of which may be valuable to you as your pursue your goals. So, as you build, maintain and adjust your portfolio over time, keep an eye on the changing prices of your investments — but don’t overlook their true value.
Tommy Mcdonald is a financial advisor at Edward Jones in Natchez. He can be reached at 601-446-5666.