ATLANTA, GA (August 10, 1999) -- We've talked a bit here in the Drip Port about the market's efficiency. Personally, I believe the market is somewhat efficient. The idea is that the market will tend to take all known factors into account in pricing stocks, and generally all stocks are fairly priced for the return that is sought from them. The problem with market efficiency is it assumes the majority of investors rationally evaluate each and every stock, and use a reasonable method of valuation.
If most investors rationally evaluated stocks, we would never see the bubbles that occur in prices of different stocks. We've all seen the excitement that happens around certain stocks once they start to rise. Everybody talks about them on CNBC, the chat rooms are full of discussion about them, and the day-traders are jumping in and out as these go up every quarter point.
Inevitably, short sellers start to jump in and talk trash about the companies, and bearish articles start to appear. Some time ago I made a very tongue and cheek post to the Coca-Cola board where I referred to this as an "Hysteria Index." This spawned the Hype and Hysteria message board (a parody of everything and anything), but I still think the "Hysteria Index" may actually have some serious value.
The worst part about a rising Hysteria Index is that everybody seems to get sucked in. My IRA brokerage account is taking a merciless pounding right now because I bought a couple stocks at their peak Hysteria Index -- I'll admit it, it was the excitement of the chat rooms that did it to me. Fortunately, most of my investments aren't in that account (at least taking into consideration the latest stock price drops!). They are in Drips and my S&P 500 index fund in my 401(k) plan.
Drips and index funds are generally Hysteria proof. It's hard to get any excitement up on the chat rooms about companies like Johnson & Johnson (NYSE: JNJ). Granted, Intel (Nasdaq: INTC) does occasionally attract the occasional Hysteric, and Coca-Cola (NYSE: KO) saw its Hysteria Index go quite high last summer. For the most part, though, the Hysterical prefer the flashier companies, such as ones with "dot com" in their name. Some time ago it was the Y2K stocks, and every now and then a penny stock will jump on the Hysterical screen. Remember Systems of Excellence (Nasdaq: SEXI)?
The beauty of investing in a Drip is it is mechanical. Every month a certain amount goes in and stock is bought. It doesn't matter what people say about it in the chats, or which "expert" appears on CNBC to give his or her opinion of this company. If Barron's comes out with a misinformed bearish article, we just end up buying more stock. If every day-trader on the planet margins to the hilt to buy your Drip stock, it doesn't matter either. You just buy less of it. The bubble may inflate or burst, and it affects us little.
Finally, as the market works its way through the hype, and the Hysteria Index of any given stock goes back to normal, we find ourselves on the upside. Perhaps this is another example of how consistency in an investment approach can benefit us. The emotions are taken out of the equation, and the investment approach stays on track through thick and thin. It's not as thrilling as buying stock in a "dot com" company, and gives us little to talk about at midnight in stock chat rooms. However, we can consistently get positive returns, which is the whole point of this anyway.