PRICE IS WHAT YOU PAY, VALUE IS WHAT YOU GET
Warren Buffett (30 August 1930 - ), American investor
In our article on "inflation", you have learned that even if you do nothing else with your money than keeping it under your mattress, its value will decrease over time because of rising prices (inflation).
On the other hand, if you deposit your money on a bank account or if you invest it, its value is also subject to a number of different influences. These influences are not only extremely varied, many of them are interrelated and influence each other.
Can you imagine that even a natural phenomenon can have an impact on your investment? If you think this is a joke, you’ll be surprised.
The way the value of an investment is established is often complex. But if you always keep some simple basic principles in mind and use common sense, you are likely to identify and understand most of the factors that may have an impact on the value / price of your asset.
First, be aware that the value of your asset – be it gold, real estate, securities or noble wines – is nothing other than the price others are ready to pay to acquire it. The value of your investment will therefore depend on all the events that have an impact on the price of the asset you have invested in.
With few exceptions, prices follow the law of supply and demand.
Goods that are available only in limited quantities and that many people want to have are expensive, because those who offer may charge higher prices and will still find consumers who are willing to pay these high prices.
On the other hand, goods that exist in abundance and that few people want to have are of very little or no value at all. That’s why you will not make a fortune when trying to sell ice cubes at the North Pole or sand in the Sahara. However, selling ice cubes in an oasis in the middle of the desert would be a much more promising business model.
A second principle to keep in mind is that investors are normally seeking the investment that promises the highest return. In other words, they look for the investment that offers the highest regular income in the form of interest or dividends or the best chance that its value – or price – will increase over time.
And that brings us to the third principle: supply and demand of assets – gold, real estate, securities, fine wines … – are largely determined by investors’ expectations about the future development of the prices of these assets.
However, keep in mind that these expectations are not always realistic.
Sometimes the incorrect or too optimistic interpretation of information, rumors, myths… can trigger a real euphoria among investors and lead them to buy “because the others buy” (the famous “herd behavior”) which may push up prices for a specific asset excessively. This is called a speculative bubble.
This is why any investor is well advised to use common sense and ask himself if the prices required on the market for a particular good are reasonable. And always keep in mind the saying of the famous American investor Warren Buffet, mentioned above: “Price is what you pay. Value is what you get.”
Let’s come back to the three fundamental principles above mentioned.
We can reduce them to a single, simple question, namely: What events are likely to impact investors’ expectations regarding the future evolution of the price of my investment asset, and what will this impact look like?
This question may seem simple enough, but answering can be tricky.
The reason is that the factors that may have – and do have – a positive or negative impact on investor expectations and therefore on the prices of capital goods are simply too many and too varied. Factors may include:
Financial institutions, asset managers and investment advisors employ legions of analysts who follow closely what happens in the economy, politics and society in general and try to deduce the potential impact on financial markets. Very often there are different ways to assess the potential impact of specific events. There is rarely a single truth. Any individual investors, any brokers have their own beliefs and expectations, and that’s exactly what makes markets work.
Making wise investment decisions requires a lot of information, knowledge and, sometimes, imagination. Those who lack the time to collect, analyze and evaluate information on at least the main elements that could impact their investments would be well advised to seek professional assistance.
We said above that even a natural phenomenon can have an impact on your investment. We still owe you the explanation.