Over the past few years, I've often considered this question: "What is the difference between investing in stocks and buying a business?" In either case, you evaluate what the future prospects are, how profitable the venture will be, and what you expect your return to be. However, if you buy a business, your future is tied heavily to how it performs. Let me use a convenience store for an example of a business you might buy.
When you buy into a convenience store, you need to put up a lot of capital, and probably borrow a lot, too. The bank may require you to pledge some of your personal assets (like your home) as collateral to make sure you don't just walk away.
It goes on further. You have to do a lot of work to get the thing going. You have to hire the staff. You stay awake at night looking at the books and charts, and if the venture loses money you could face personal ruin. What gives you the energy to do this? I think it's partly your emotions -- the business becomes part of you. You identify with your convenience store. It is your personal monument, your life.
Now, many of us may not want this kind of risk, but we would like to get a return on our funds that a good investment or venture provides. There is a way, of course.
Like a small business, larger companies need investors, too. Companies like Intel started with venture capital, and then proceeds to an IPO. The day any company like Intel goes public, there is still significant risk involved. Many of us would not want to invest in companies if we faced the same types of risks that you must face when you start your own business. Would you want to worry at night about losing your assets in a lawsuit against a company that you owned stock in? Or, if the company you invested in goes out of business, how would you feel if the creditors came after your boat and vacation home to pay off the debts?
The system of buying and selling stocks has evolved over time to eliminate this "extended" personal risk to us. If I own a convenience store and it looks like a bad investment, selling it can take months, or even years. If a highway realigns and I lose all my customers, I'm probably stuck riding the business down, or trying to liquidate it and losing a lot of money. However, if my stock isn't doing well, in most cases I can dump it in minutes.
My personal assets aren't used as collateral for debt in companies I own stock in, but they might be if I bought a convenience store. If the company faces a lawsuit, in most cases it doesn't affect me -- I don't have to go in and give depositions in all the different lawsuits that Intel faces all the time. My Errors and Omissions insurance doesn't have to cover me for risks that Lucent Technologies may face in lawsuits because I have a Drip in them. In my stock investment, I get the benefits of business ownership for a potential return on my investment, but much less of the personal risk.
However, being humans, we still figure out how to make a mess of this system. Many of us get very emotional about our stocks. They become our favorite team, or we begin to identify ourselves heavily with these companies. We can even add to the financial risk by buying on borrowed money (margin). Or, we can use the capability to buy and sell these investments quickly to increase our risk through short-term trading strategies. All of a sudden, the advantages of investing in stocks over starting the convenience store begin to disappear.
While short term trading and margin aren't really risks for us as Drip investors, getting emotional about our companies is a serious risk, in my opinion. After you own a company for years and have invested in it regularly for just as long, you get attached to it. I know when I've sold Drip holdings, I felt this vague sense of guilt. Take a look in the stock boards at how angry some people get when bearish comments are made about their company.
As long as your investment does well, your strong devotion to it doesn't seem to be a problem. If your investment starts to underperform, however, will you be able to see it? If you are emotionally involved with it, you may not be able to. Just like the convenience store example, your personal financial situation could be dragged all the way down as your investment slides down the tubes. Markets change, business models change, and people in charge of companies move on. When this occurs, the company that was a great investment when you bought into it could be as irrelevant as a buggy whip manufacturer became early in the 20th Century.
For many reasons, there are those of us who have our own businesses. It's often due to a desire to build something, to be our own boss, or a feeling that we can do something better. However, even those of us who own businesses invest in stocks. Stocks allow us to increase our wealth without the same aggravations that our personal ventures give us. To accomplish this successfully, though, we need to stay detached emotionally from our investments, and be able to make rational evaluations of when it is time to buy or sell.
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