Future Expectations

Every stock that you own is an ownership stake in the future profits of some business. Naturally, these future profits may not be realized or may fall short of expectations which could lead to decline in the stock’s value. But what do these profits depend on? Mainly two things : the profit margin and the total revenues earned by the firm. You multiply them and voila, you have the profit. Now imagine that you combine all the publicly traded companies in America into one giant corporation. The performance of the “stock” of this entity is approximated by well-known indexes like the S&P 500, the Dow etc. We call this thing the “stock market” or just the market. We will get to bonds and other asset classes later, but similar rules apply there.

One reason why thinking about the market as a whole is useful is because the total sales of this construct correspond approximately to the Gross Domestic Product (GDP) of the United States. In other words, you could expect the total market sales to grow approximately at the rate of growth of the economy as a whole. It’s nice to be able to link the market to something in the “real economy”!

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What is Risk?

There are few things in the world of investing that are as often misunderstood as the matter of risk. In my career, time and again, I have found it an uphill battle to impress upon investors that they must figure out their risk appetite before anything else. It doesn’t help of course that various billionaire legends regularly pour cold water on the very notion of risk. “Where is the risk?” they ask. If you know what you are doing, there is no risk, right? And after all, who doesn’t know what they are doing?

Warren-Buffett
A popular internet meme reminding investors of Mr. Warren Buffets wisdom.

Plenty of people as it turns out.

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