Recs
By Morgan Housel | More Articles April 3, 2012 | Comments (19)
While reading Josh Brown's book Backstage Wall Street this weekend, I came across this quote from current New York Times columnist Joe Nocera. It's from 1995, when the Dow Jones (INDEX: ^DJI ) traded at around 4,000. Back then, Nocera couldn't believe the optimism sweeping investors away:
Funny: By 2000, the Dow traded above 11,000. How many times in history have the most optimistic investors been off by 70% on the upside? As far as I know, never.
I won't ramble on about how big the dot-com bubble was or how dumb investors were back then. That got old years ago.
But there's a related point that's still worth talking about. What's interesting about the 1995 forecasts Nocera cites is how rational they were. Since the 1950s, the Dow has increased by an average of 6.8% a year (before dividends). With the Dow trading at 4,000 in 1995, the analysts polled in Nocera's article were forecasting annual returns of 5% to 9% -- normal, average returns, basically.
In other words, assuming valuations were reasonable in 1995 (and they were, for the most part), the Dow should have traded somewhere between 5,000 and 6,500 in 2000. That's where you should have expected it to have been had there been no dot-com bubble.
Now, if the Dow had traded at 5,000-6,500 in 2000, think about what that would mean for investors today. Instead of the "lost decade" investors endured from 2000-2010, they would have earned an average annual return of 6% to 8.5% a year -- almost exactly average, historically.
Here's another way to think about this. The light line below is a hypothetical Dow increasing 6.8% a year (the historic average) starting in 1995. The dark line is the actual Dow:
Sources: S&P Capital IQ and author's calculations.
Did you notice? The two lines end in the exact same spot. Returns from 1995 through today have been almost exactly average, historically.
And yet think of all the frustration over lousy market returns lately -- disgruntled investors sullen over the fact that most money invested over the last decade has lost value after inflation. Without question, the last 10 or 12 years have been an awful time for most investors.
The takeaway from that is really important:
I know. You might think it's Monday morning quarterbacking for me to say, "Look, if you invested in 1995 instead of 2000, you'd be rich today!"
But that's exactly what I'm saying, and I think it needs to be repeated over and over again. For the literally tens of millions of pages of market analysis and financial advice out there, smart investing really boils down to just three points:
Anyone who bought from 1997-2000 or 2006-2007 when valuations were high and felt cheated two or three years later as returns sank broke all three rules. Many more will do so in the future. And just like over the last decade, they'll sit in shocked disbelief, wondering what happened, when the honest answer is, "Nothing unusual."
As Ben Graham, Warren Buffett's early mentor, used to say, "In the short term, stocks are a voting machine, and in the long term, stocks are a weighing machine."
During no time has that been more evident than 1995 through today.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
Read/Post Comments (19) | Recommend This Article (48) Recommended 48 Times
Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.
The current rally appears to follow this trend line ...
http://farm8.staticflickr.com/7047/7019351163_b3ce9787fd_b.j....
from comment #13 here -> http://caps.fool.com/Blogs/chart/693386.
That trend line for the closing values of the S&P 500 index
f(t) = f(0) * exp ( 1/15 * t^0.37),
where t counts the trading days since March 9, 2009 (t = 0), thus f(0) = 676.53
currently (t= 755 for April 3, 2012) increases by around f'(755) â?? 0.5515 per trading day (there are around 252 trading days per year), so at "current trend line speed" the index rises by around 10% p.a..
"In the short term, stocks are a voting machine, and in the long term, stocks are a weighing machine."
Does TMF have an editorial policy requiring the daily use of this quote?
^ We use it so frequently because the lesson is so often ignored or forgotten.
"Ignore what happens in between. If you choose to watch, be assured: It will be ugly at times."
It's a matter of accentuating the positive, isn't it? I actually have a routine, a process I can employ to keep myself focused on the big picture. On those days when my investments are performing well, I think to myself "I made some decent money today." On the days when I take a bath, I think to myself "Look at all these excellent buying opportunities!"
These are the kind of articles I like to read. Thanks Morgan. I sometimes feel like I get more out of my Fortune magazines from the '80s that I got off Ebay than my current Fortune subscription that I subscribe to. Many times the past is a good indicator of the future.
Actually the editorial policy requires mention of Warren Buffet, Ben Graham, Charlie Munger, Peter Lynch, or John Bogle in at least every third article. Just like ads touting the next big stock have to include something about Warren, Bill Gates, or Steve Jobs.
It seems to me that the Dow run up in the mid to late 90s was in no small part do to the Fed's currency creation during the same period. Although it in no way compares to the current era (2008-present). Actually, the "current era" should include the whole 1st decade do to Fed actions following the dot.com bubble burst.
By the way, maybe I'm just not very bright, but what the hell does "weighing machine" mean in the context of that quote? I've never understood it.
seattle - it means over time the quality companies will win out as the short term erratic/irrational behavior of people will not affect these good companies
Dollar cost averaging FTW
I really hate the term "lost decade", it wasn't lost unless you had horrible timing. I started investing in 2006, and have been increasing my 401K contribution each year, minus the time spent unemployed. That has been a real test of my patience. My returns have been crap thus far because the generation before us pillaged the market, and decided to buy houses 5 times bigger than they could afford. But I still have made money, and think that I may have a great retirement because I will be buying into a low/slow period over the next decade. Then I'll ride the next wave(s) up.
@MNGPHR: "it means over time the quality companies will win out as the short term erratic/irrational behavior of people will not affect these good companies."
Hmm. Seems like a rather clumsy metaphor, but whatever. I guess the general intent was clear enough, and it's accurate (up to a point).
@CaptainWidget: "Dollar cost averaging FTW"
What CaptainWidget said.
Hey Morgan,
Great article. Love the graph, very interesting premise. Not sure if I buy it 100% but it is compelling.
I am with you though on your investment strategy. Buy reasonably valued, and hold. Done. Nothing else necessary to focus on.
Thank you for your perspective. One of my many pet peeves about financial writers is that they will cherry pick a historical period to prove their thesis. Shame on every writer who does this.
Good article morgan. Long term value investing in my opinion is and will always be the best way to build wealth. "The Intelligant Investor" by Benjamin Graham is the single best investing book for someone who wants to follow this method. Buy companies with an established brand, have a long history (decade) of paying a dividend and when market cap to gdp is under valued.
I read an article back in Jan 09 saying Warren Buffet made large purchases during and right after the market crash in late 08. Buffet stated when investors are scared I go a buying. It is very hard to eliminate emotion, expecially when your own money is at stake, but is prudent in the process to make money. Benjamin Graham and Warren Buffet are investing legends as Kobe Bryant and Michael Jordan are to basketball. When these guys tell you how to be successful you would be foolish not to listen.
This investing concept works because money is not added to the market; instead it just changes hands. The market works around an equilibrium point the ups and downs of the market are just flucuations from that point, and will "always" return to its natural equilibrium. So do your homework on the markets/companies you will be investing, remove emotion from investing, never buy after a big gain/never sell after a big loss and buy entities you are willing to hold forever. Investing and basketball are my two passions and I get the same amount of enjoyment from both. So good luck investing and enjoy it otherwise it isn't worth doing.
Read Full Article »