An experiment I’ve used in presenting to groups of people is to fill up a jar with jelly beans and pass it around the room. I ask each person to estimate the number of jelly beans in the jar, then collect the guesses and tabulate the answers. If the jar contains 1,046 beans (which was the actual count in one jar I used) the range of guesses may be from 120 beans to 2,050. When I compute the simple average of all the guesses, it turns out to be 1,030, very close to the correct number. The larger the group, the closer the result. This illustrates an interesting point: the collective wisdom of the group is better than the individual guesses of most participants.
So, what does this have to do with investments? Plenty. Suppose you are interested in buying a certain stock, for example, Walmart. Walmart’s current price is $160 per share but you’re convinced it’s worth $190. So, your idea is to buy Walmart at $160 and then hold it until it hits $190. At that point you sell it and make a nice $30 profit. Sounds pretty simple, doesn’t it? But there’s a problem with this strategy. It has to do with the collective wisdom of the group, just like in the jelly bean example. On any given day, there will be thousands of buyers and sellers trading Walmart stock. Buyers are buying Walmart because they expect the price to go up in the future. Sellers are generally selling Walmart because they expect the price to go down in the future (or they may just need cash to buy something). The interaction of all these buyers and sellers coming together has established a price of $160. The $160 price reflects the world’s judgment on what Walmart is worth based on current information. It’s the collective wisdom of a large group, a group much larger than my jelly bean trials. And it’s a group that includes sophisticated players who do this for a living!
Of course, new information comes out continuously about Walmart. “Sales are up”, “margins are down” “Christmas season is slow” etc. An endless stream of information causes Walmart prices to adjust during the day as investors reassess what Walmart is worth. So, the price is changing constantly. While you may be confident of your $190 price prediction, keep in mind that the rest of the world says its worth $160. I don’t want to dampen your enthusiasm but the odds of you being right are not that great. But don’t be discouraged. The professional money managers can’t get it right either. When measured against well-established benchmarks, very few portfolio managers do better than overall market averages over time.
This is not meant to discourage you from investing in stocks. But it is a reminder to consider not betting significantly on a single company. The stock market rewards patient investors over time who are diversified among many companies. You can do this by using mutual funds or exchange traded funds (ETFs) that are broadly diversified. You have a much better chance of success than betting against the collective wisdom of the group. There’s a lot to be learned from a jar of jelly beans!
