Value, Value, and then there’s Value

Recently, I was having a conversation with an investor regarding her investments.  Most of her stock investments are passive index based.  We discussed the current investment environment and she was having thoughts of possibly taking some of the profits she has and diversifying a bit more.  She wanted to add a small portfolio that consisted of businesses she liked using and wanted to support.  She was providing me with background on her index based investments, and how she chose them.  She said her discount brokerage provided her with some suggestions, and then went over diversification before choosing and purchasing.  She provided me with the prices she purchased the index investments at.  I asked her if she knew what the values of these index investments were at the time of purchase, and she looked at me with a blank stare.  She then asked isn’t the price the value?  Price is not value, and never will be.  Don’t ever confuse the two, and yes there are multiple ways of placing value on an index.   

Value is all that matters.  No matter what you are buying or selling.  When you purchase a house, a car, an insurance policy, a set of golf clubs, a surfboard, or a college education for your child most will focus on the value of what they are getting for that item as determined by the current market for that item.  Most wouldn’t pay twice the price for a new house when the value of the other houses on that street are one half of what the asking price is.  A lender wouldn’t provide a mortgage for a house after they see the appraisal report and the comparison values showing the house valued at twice the market price.  Everything has a value.  Sure an emotional or sentimental value can be placed on an item whereas someone doesn’t care about the financial value, but for most people and in most situations financial value is all that matters.  We as humans value everything from what we are discussing in this article to relationships.  You cannot, as an investor, ever purchase an investment without understanding what it’s financial value is.  Doing so elevates your risk, and could lower your return substantially.

Nine out of ten people I talk with about index investing don’t consider financial value when investing in the index.  Most refer to the overall market being down or not in a bubble, or they refer to how they are in it for the long haul.  The reality of the long haul is the same as a house.  Most live in their homes for long periods of time, yet they know the financial value of the property when they purchased it.  It shouldn’t be any different with an index investment.  Indexes don’t stay stagnant and the price of the index versus their values isn’t always efficient irrespective of what some preach.  All you have to do is look back over time and see the fluctuations on a chart.  For example, if an investor invested in the S&P 500 index around the recession that started in 2008 the valuation of that investment varied greatly over a three year time period, and the same happened in the tech bubble of the 2000 era as two simple examples.  Over history there are many more examples that can be seen.  Just because historical averages paint pretty pictures, be smart and don’t get sucked into time solves all, because it doesn’t always.  Financial value is the investors friend.  Use it.