Mutual Funds: Portfolio Structures, Analysis, Management, and Stewardship

CHAPTER 5

How Financial Markets Work

LARRY E. SWEDROE Principal, Buckingham Asset Management, LLC, St. Louis

 

 

 

Despite its obvious importance to every individual, our education system almost totally ignores the field of finance and investments. This is true unless you go to an undergraduate business school or pursue an M.B.A. in finance. The result is that individuals are making investments without the basic knowledge required to understand the implications of their decisions. It is as if they took a trip to a place they have never been with neither a road map nor directions. Lacking a formal education in finance, most investors make decisions based on the accepted conventional wisdom—ideas that have become so ingrained that few individuals question them. Unfortunately, most of the conventional wisdom about investing is not only wrong, but it is illogical.

The goals for this chapter are threefold. The first is to explain how markets really work, doing so in a way that makes it easy to understand even difficult concepts. I hope to accomplish this objective through the use of stories and analogies that present the logic in a paradigm with which you are already familiar, and then relate that logic to the world of investing. If you understand the logic in the story, it should be just as clear when the logic is related to investing—especially when the evidence supports the logic.

If I am successful in meeting the first objective, I will have also achieved the second objective—to forever ...