FOOL ON THE HILL
The Clean Slate

Every New Year gives investors an opportunity to begin anew. Investors should not forget their returns from previous years, but they should be benchmarking to a major index to make sure that they are outperforming the market. With the markets having gone down now for two consecutive years, you might be surprised that a 1-2% loss is actually pretty good. The goal in buying individual stocks is to beat the market. If you haven't by now, it may be time to ensure yourself the average.

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By Bill Mann (TMF Otter)
January 2, 2002

Stop.

Before you do anything else, go print off a copy of your portfolio. We are at the first day of the New Year, so you've got the opportunity to start benchmarking your portfolio returns.

Get the opening day prices for the S&P 500, Dow Jones Industrial Average, the Wilshire 5000 and the FOOL 50 as well. These are indices, the things that show how a sampling of some of the largest and most important companies are performing. Tell you what -- I'll do that for you.

Jan. 2 Opening Prices:

S&P 500           1,148.08
DJIA                10,021.71
FOOL 50           1,419.55
Wilshire 5000   10,818.57

These are the baselines for the indices, your portfolio's value is the baseline for your own performance through 2002.

Now, as we all know, the point in investing is to beat the performance of the market in general. Which index, then, should you use to track the relative performance of your portfolio? Well, it kind of depends. I generally think that the best gauge for stock performance is the trusty S&P 500, which is comprised of 500 of the largest American companies, and represents about 80% of all of the value on the U.S. stock markets. In other words, the big 500 companies combined are 4 times the size of the smaller 10,000 ones. But if you include some small-cap stocks in your portfolio, perhaps the Wilshire 5000, which, in spite of the round number in its name, tracks every stock listed on the U.S. exchanges. If you've got a few foreign stocks, maybe the FOOL 50, which has a mixture of U.S. and international companies, would be preferable. We're fond of our own index, but it is still only two years old, so it isn't really seasoned as of yet.

Investors have just gone through two gut-wrenching years with stocks. Starting in March of 2000, the Nasdaq has shed more than 60% of its value. At the end of last year, 7 of the 100 companies in the Nasdaq 100 Investment Trust (Amex: QQQ) traded under $1 per share; 52 of the 100 companies lost more than 70% of their value from the peak. These are companies that nearly everybody wanted to own -- many of us owned at least one of them.

How about this? Of the top 100 companies listed by Barron's in the second of its controversial "Burn Victims" series from October of 2000, only 26 are still listed. Eighteen are penny stocks, with values as low as $0.019 cents per stub, and the remaining 56 no longer exist. Of these, only two were merged, and one of those mergers failed to save the company. Only 9 have market values above where they were in October 2000, most notably Expedia (Nasdaq: EXPE), Digital River (Nasdaq: DRIV), and LendingTree (Nasdaq: TREE).

What's funny about this was that Barron's was hammered by companies and pundits alike for this series, with screams abounding that once again, the old line newspaper's editors just didn't "get it." The Fool's offerings on this topic were scant, with my colleague Brian Lund complaining about one particular company on the list, but generally we were pretty fond of the warning Barron's was giving to investors about investing in second-rate companies that were bleeding money.

And yet, it was also this time when the exuberance of investors was at its height, when the words "well, if you are satisfied with 35% annual return" somehow did not seem absurd to a lot of investors. It WAS absurd, and for many of those who felt 35% was not good enough, it ended badly. Lesson learned, I can only hope.

Well, that's over now. It is 2002, and we are following up the first consecutive year losses by the major indices since 1973-1974. Where 35% growth may not have been acceptable to some in 1999, when it comes down to it a negative 1% or 2% return in 2000 and 2001 was pretty good, and would have trounced the indices.

That's the goal in investing in individual equities -- to beat the indices. No, losing money is not the basic point of investing, but there is no such thing out there that says the markets must to go up each and every year. They don't. They probably can't. So while I am not saying that an investor should be satisfied with a loss, we must understand that there are years in which losses are inevitable. Even superinvestor Warren Buffett will see a streak end this year: Berkshire Hathaway (NYSE: BRK.A), which has had 36 consecutive years of increasing book value, will have lost some ground in 2001. Still, what's important for Buffett and his long-time investors is that Berkshire has only failed to beat the S&P 500's performance 3 times in that stretch, and is likely, even with a loss, to do so again for 2001.

The new year is underway, so it's time to track your performance anew. Many people are not so fortunate as to have beaten the S&P 500 over the last two years. If this is you, maybe your new year's resolution should  be to place yourself on probation. If your mutual funds haven't beaten the index over the last two years, put THEM on probation. If you do not beat the S&P 500 through 2002, perhaps this is the time to think about joining it instead via an index fund?

Right now, you're at square zero. Best of luck!

Bill Mann, TMFOtter on the Fool Discussion Boards