Wednesday, 1 October 2008

The Self and the Other

An aspect of the recent stock market meltdown has led me to some philosophical musings regarding ourselves versus other people.

When they say trillions have been wiped off the stock market, what do they mean exactly?

The market value of the stock is what the market thinks it is worth. Obviously, when a crash happens, a lot of people suddenly think a lot of stocks are not worth what they thought they were worth just hours earlier, and they put their money where their opinions are by not being willing to pay the earlier price for them. It's just opinion that suddenly changes. Nothing in the real world has changed in such a short period of time except some trigger event.

The reasons for the change of opinion have been heavily researched, and will no doubt continue to be heavily researched, but my immediate concern is something else.

Why are people suddenly "poorer" after a stock market crash?

If the bulk of a person's savings is held in the form of shares, either directly or indirectly (through mutual funds that invest in shares) [or even more indirectly (through retirement savings plans that invest in mutual funds)], their "wealth" is not measured by how well they dress and eat and live but by the value of the shares in which their entire life savings are ultimately invested. I have been oversimplifying by using the word "shares" when I should have been saying "assets", which include real estate, commodities (gold, oil, wheat) and securitised versions of these.

When the market value of assets crashes, the owners of those assets become poorer overnight.

In other words, in a financial sense, we are ultimately worth what other people think we are worth.

How starkly this contrasts with Eleanor Roosevelt's reassuring admonition that no one can make us feel inferior without our consent!

But on reflection, I realise that the two statements are not saying different things at all. When the market suffers a "correction", it implies that the new value of the assets we hold are the "correct" ones. Therefore it can only mean we bought them at unrealistically inflated prices. In other words, we accepted other people's opinion of what they were worth at the time we bought them. That's why we're now poorer. We have allowed other people to make us feel inferior because we earlier (wrongly) allowed an aspect of our true worth (our savings) to be pegged to other people's inflated opinions of various assets.

So Warren Buffett and Eleanor Roosevelt are essentially saying the same thing. Look for the fundamentals, for true worth. If you are blindly led by the opinions of others, they can make you feel superior for a while while the market continues to boom. But when things return to their "true" value, they can make you feel inferior as well. And it can really hurt.

On the positive side, if you invested in true value and the market has now crashed to take the price of your assets below their true value, there's no need to feel down. Things will eventually return to normal, and you will once again be seen to be worth what you are (in financial terms). Just don't panic and sell :-).

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