IPO — With as much volatility in the financial markets as we've seen over the last decade, it's about time to revisit the entire point of why they exist in the first place. Unfortunately, for a growing number of investors, markets today are viewed as glorified casinos. For the health of our economy, this notion needs to be dispelled. To do that, investors need to stop acting like traders and start thinking like investors.
The public market's first and simplest function is to provide a way for original investors to cash out. Remember an initial public offering — anis driven by someone more knowledgeable than you wanting to sell out. That's reason enough to be careful when buying into IPOs. Facebook's IPO, for example, was orchestrated by bankers whose sole job was to find willing buyers who would pay the highest price possible for their shares. Based on the immediate drop in Facebook's share price following the IPO, the bankers did their job really well.
The market's second and most important function is for a much higher purpose. Stock markets are like beehives. Like worker bees totally unaware of the complex design of the hive itself, investors blissfully buy and sell shares all day long. The ultimate result of all this activity is to fulfill the market's almost forgotten function of properly valuing business ideas. This valuing of ideas is a complex dance, for sure, but it is done to help our economy allocate capital to its best and most productive use. When done correctly, it helps channel money to individual businesses and entire industries that will best meet the demands of society.
While the markets get it really wrong sometimes — think tech stocks and the housing market — human beings really haven't yet figured out a better system.
However, for markets to work efficiently, investors must think for themselves. Without enough collective thought, being in the market can feel like the rolling of dice. A lot of investors are, in fact, rolling the dice.
Markets fail when investors buy and sell shares without thinking about the underlying companies they own. They fail when investors rely entirely on high-speed computer algorithms designed to outwit other algorithms designed by other math whizzes who probably should be contributing to our society in more productive ways.
Markets get it wrong when financial decisions become distorted by the actions of a few central bankers and politicians around the globe.
Many investors today have staked their entire life savings on the premise that they can simply piggy-back on the deep thinking of others investors.
When too many investors follow this course, it becomes the blind leading the blind and results in the market wildly jumping up and down.
It's time for investors to embrace the idea that there is no substitute for active and independent thinking.
Financial markets actually depend on it.
Jason P. Tank is a Chartered Financial Analyst and co-owner of Front Street Investment Management LLC, a local fee-only investment advisory firm. He encourages questions and comments about future columns which can be directed to (231) 947-3775, by email at email@example.com and at www.frontstreet.com