Saturday, October 11, 2008

The Truth About Valuations in the Market

If you think you've lost X dollars in the stock market this past month, or X percent over the past year, you've got another thing coming.

You haven't lost a penny unless you were to sell at this point. It means that if you're 30+ years from retirement, you should still be in good shape and will likely benefit from the down market to continue adding shares at a new and more reasonable pricing based on valuation and worth of the stock, but if you're planning on retiring in the short run, your investment portfolio, 401(k), Keogh plan, or pension took a nasty hit.
Robert Shiller, an economist at Yale, puts it bluntly: The notion that you lose a pile of money whenever the stock market tanks is a "fallacy." He says the price of a stock has never been the same thing as money — it's simply the "best guess" of what the stock is worth.

"It's in people's minds," Shiller explains. "We're just recording a measure of what people think the stock market is worth. What the people who are willing to trade today — who are very, very few people — are actually trading at. So we're just extrapolating that and thinking, well, maybe that's what everyone thinks it's worth."

Shiller uses the example of an appraiser who values a house at $350,000, a week after saying it was worth $400,000.

"In a sense, $50,000 just disappeared when he said that," he said. "But it's all in the mind."

Though something, of course, is disappearing as markets and real estate values tumble. Even if a share of stock you own isn't a wad of bills in your wallet, even if the value of your home isn't something you can redeem at will, surely you can lose potential money — that is, the money that would be yours to spend if you sold your house or emptied out your mutual funds right now.

And if you're a few months away from retirement, or hoping to sell your house and buy a smaller one to help pay for your kid's college tuition, this "potential money" is something you're counting on to get by. For people who need cash and need it now, this is as real as money gets, whether or not it meets the technical definition of the word.

Still, you run into trouble when you think of that potential money as being the same thing as the cash in your purse or your checking account.
The value of the stock market will come back to its former levels, but it will take time, and it will require that the market regain its confidence in the credit markets that the toxic paper has been dealt with. The problem is that no one quite knows when that will be, how many other companies are on the brink as a result of tight credit, and what it will take to get the markets back on solid footing. It is quite possible that the government actions - the $700 billion bailout will actually lengthen the pain and anguish in the markets, rather than relieve and shorten them. Instead of purifying the markets of the toxic effects, the bailout will give companies incentives to continue operating as they did before.

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