Intelligent investors understand the importance of stock-market history

This is an excerpt of a summary of the Intelligent Investor. You can choose to read the article or simple read these next 3 words to save your time and pain – buy index funds.

Looking back through history reveals that the stock market has always been defined by regular ups and downs. Often, these fluctuations can’t be foreseen. The unpredictability of the market means that investors need to be prepared – financially and psychologically.

Economic crises, like the Wall Street crash in 1929, are a fact of life, and happen from time to time.

Thus you need to ensure that you can take a big hit and survive. This means that you should have a diverse stock portfolio, so your investments don’t all get hit at once.

What’s more, you should be mentally and psychologically prepared for crisis. Don’t sell everything at the first sign of danger. Remember instead that, even after the most devastating crashes, the market will always recover.

And while you can’t predict every crisis, looking at the history of the market will give you a better idea of its stability.

Once you’ve determined that the market is stable, focus on the history of the company in which you’d like to invest.

Look, for example, at the correlation between stock price and the company’s earnings and dividends over the past ten years. Then consider the inflation rate, i.e., the rise in prices generally, in order to see how much you’d really earn, all things considered.

For example, you calculate a 7-percent return on investment within one year, but if inflation is at a 4-percent rate, then you’ll earn a return of only three percent. Think carefully about whether it’s worth the effort for only a three-percent return!

When it comes to shrewd trading, a knowledge of history is a fine weapon, so be sure to keep it sharp.

The first thing you should do before you invest isn’t to look at a stock’s history. That’s important, sure, but what’s more important is looking at the history of the stock market itself.