PERFORMANCE ANNOUNCEMENT
As Of: May 17, 2002
Wall Street Wisdom
"If it were easy, we would all be millionaires." This statement is a succinct description of the art of investing. It is true that investing is not easy; but doubling your effort will not necessarily lead to success. If you don't know what you are doing, trying twice as hard only expands the possible ways you can fail. Knowledge and experience are the important partners to effort. Market knowledge used to be held closely in the hands of the professionals. This is no longer the case, so access to information no longer separates successful investors from the rest. The only thing worse than not having sufficient information, is believing information that is incorrect. Technology has unleashed a flood of information to the public. Some information is good, some is bad, and much of it is useless. Knowing what information to rely on is one of the most significant challenges for today's investors. This is where effort and experience pays off. The following common statements of Wall Street wisdom can be very misleading:
1) Stocks always go up in the long run. Wrong! Stock indexes go up because the stocks that make up the index are constantly changed. (They get rid of the losers and keep the winners.) Individual companies go through life cycles and their prices go up and down accordingly. Young, successful companies tend to grow rapidly. Mature companies tend to stagnate. If a mature company does not reinvent itself, or is not bought out or broken up, it usually goes into decline.
2) Diversifying among more than 8 or 10 positions does not add much, and probably dilutes performance. While true mathematically, the focus of this statement diverts attention to the number of positions rather than the definition of diversification. Owning ten different technology stocks did not protect investors when the tech sector collapsed. Diversification for risk management should be focused on asset classes, not individual securities. Proper diversification means holding positions with inverse correlations. Another approach is to select asset classes to protect against specific risks. For example, currency exchange rate risk can be addressed by diversifying among foreign investments. Interest rate risk can be addressed by diversifying across maturities and into non-interest rate sensitive investments. Security market risk can be mitigated by investing in hard assets such as real estate and commodities.
3) Nobody can successfully time the market. This leads to the conclusion that investors should buy and hold. Wrong! (See number one above.) Wall Street brokers trot out the University of Michigan study that shows how missing the best 90 days of market performance over a 31 year period reduced the average annual return of 11.83% down to 3.28%. While this plays to the fear of missing the best up days (and thus the conclusion that one should stay fully invested all the time), it is misleading. A more recent study by Biriny Associates, as reported in Barron's 11/5/01, shows that missing the five worst days each year between 1966 and 2001 produced a return 92 times better than the buy-and-hold strategy that captured the five best performing days each year. While it may not be possible to time the market perfectly, dynamic asset allocation is better than a static strategy that takes it on the chin during every bear market.
4) Buy low, sell high. If this is your only strategy for investment, then you can only make money when your investments go up. Sometimes markets chop sideways, sometimes markets go down. You are missing two thirds of the opportunity in the marketplace if you only buy long. There are numerous strategies that allow you to protect assets and even make a profit in down and flat markets. If you are not experienced with these investment techniques, consult a professional because you are competing in the marketplace against expert traders.
5) Only invest where you can identify a track record of success. Common sense dictates avoiding fly-by-night frauds and trying to invest where there is seasoned and experienced management, but this does not mean making decisions by looking in the rearview mirror. Wayne Gretzky is reputed to attribute his success in hockey to a very simple strategy: While most players follow where the puck has been, Wayne would head to where it was going to be. Successful investing has little to do with chasing last year's winners. It has everything to do with anticipating who will be next year's winners.
6) The market is so efficient, you can't beat the market. In any adversarial contest, there will be winners and losers. The object of successful investing is to be sufficiently better than the competition to come out a winner. (Be realistic: You gain money at the expense of somebody else losing their money.) A recent study by Dalbar, reported in Barron's 2/25/02, concluded "from 1984 through 2000, when the S&P racked up an average annual return of 16.3%, the average equity fund investor wound up with a yearly return of a mere 5.32%." The average individual investor has only himself to blame, not efficient market theory. The result of this study is explained by the individual investor's "inevitable tendency to pile into funds at the top of markets, accompanied by another, equally consistent tendency to lighten up at bottoms." The computation of an average requires data points on each side of the average. If a lot of people are receiving below average returns, who is making the above average returns? It could be you if you are willing to do your homework.
Being a successful investor does require hard work. It requires being an independent thinker and it requires the application of some common sense. Just as it was tempting for so many people to buy into the technology bubble with their life savings, it is equally tempting to buy into many of the Wall Street platitudes. The bubble has burst and we are back in the cold hard light of reality. It is you against "them". This is no longer a market where all boats will be lifted by the tide. The cost of errors, waste, bad judgement, fraud, and mismanagement can no longer be hidden behind the curtain of constantly rising profits for all. It is time to make sound investment decisions based on good, reliable information, and sound logic.