Before getting into tonight's recap, I'll mention that Alan Greenspan and the Federal Open Market Committee gave our portfolio a boost today, along with the market in general, with a surprise 50 basis point cut in the federal funds interest rate. For more on that news, see Bill Mann's commentary.
Who predicted that the Fed would act today? No one that I know of. It's days like this that convince us that we can't time the market.
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Envisioning the world as a building, C.S. Lewis wrote that half of us think it's a prison, and the other half think it's a five-star hotel. Those of us who think it's a prison can't believe how happy we are! Those of us who think it's a five-star hotel, on the other hand, mostly just complain.
Our expectations, Lewis is pointing out, mean a great deal. In no small way they determine our reactions, our feelings.
Now perhaps you're new to this whole investment thing, and have heard how bad the stock market's been recently, maybe even losing a bit yourself. Or maybe you're a seasoned old hack who'd just like a New Year's picker-upper a day after the Nasdaq's seventh-worst daily percentage drop. If so, remember this: The stock market's annualized historical return is a shade over 10%. Some years we have seen returns well over that, while others -- and these periods can persist over some time -- feature returns well below that. In some cases, "returns" itself is a misnomer. Because after a year like 2000, the money I gave to the market now seems in retrospect to have been some bizarre form of charity -- a charity with much less psychic reward than some others (like Foolanthropy 2000)!
Brian Lund correctly calculated in yesterday's illuminating recap that the real money in this portfolio (my real money, actually, now that you mention it) sits about $500,000 lower than it did just one year ago. That's definitely not something to brag about at cocktail parties. Indeed, it's at least arguable that such experiences -- and maybe you've had one too -- induce neurochemical reactions that inhibit one's desire to attend such cocktail parties.
I sometimes pity myself this way until I remind myself that, of course, we're all in a great big prison here, and no one gets out alive. The more we keep reminding ourselves of these things, in fact, the better we and our lives will be. We'll look around and appreciate that it really isn't so bad a prison, as prisons go. And our limited time within might as well be spent meaningfully.
I'm writing about expectations today, the five-star and the prisonlike. Particularly, the expectations of my fellow Rule Breaker investors. If you're a Breaker of Rules with some of your investment monies, your expectations are just plain different from other folks'. As you strap on your plate mail and readjust your visor for maximum visibility, you go into battle absolutely knowing that you're going to get unhorsed, rudely beaten about the head with a stick or a sword, whacked... some of the time. But let's put the emphasis on the right word: "whacked." Actually, let's put the emphasis on an even more important word there: "know," as in you know. Because the road to dynamically higher long-term investment returns ain't paved with cotton candy, and no one investing in stocks, particularly in volatile stocks, should expect smooth marble. Making money in the stock market over the long term is rough and messy.
For a Rule Breaker investor looking to reach the investor's Elysium, a good suit of mental armor -- that is, persistence disciplined by realistic expectations -- is a sine qua non. Remember Bunyan's pilgrim, who endured the Slough of Despond, the Hill Difficulty, the Valley of Humiliation, and the River of Death before he finally reached his Celestial City.
If you take all that poetry and put it into numbers you get something like this: In 1998, this portfolio returned 199%. Two years later, in the year 2000, we sagged 53%. Yesterday we dropped 6% in just one day alone. Those are staggering figures. We are indeed imprisoned by volatility, a volatility that is both out of the ordinary and yet no big surprise to me personally. I've expected it. While I didn't know that yesterday would be horrible and today would be great, I knew that there would be ups and downs on the road.
We began by pointing out that your expectations determine your reactions. Now let me observe something just as important: Your reactions tend to govern your next actions. That's just human nature, to alter or mend our ways based on the feelings created by past action. For example, if your reactions to the stock market of 2000 have shaken your previous convictions, now might be a great time to make changes in your investment allocation or strategy. However, you should also realize that your next actions can be unduly and unhelpfully influenced by your most recent, short-term reactions -- which are quite negative if you're like most of us. Many will have a tendency to want to swear off the stock market typically just before the best opportunities to buy in.
A few years ago, I came across a great mathematical equation, which seems apropos of our topic: Happiness equals reality divided by expectations. Let's notate it, for mnemonic purposes:
H = r / e
Our meditation today has been on that little "e," which is in the important position of denominator. If you keep the "reality" numerator constant and jigger around with the "e," you can see what that does to happiness.
And speaking of market expectations, I think they may be as low now as they were high a year ago. The pundits seemed as sure that Amazon.com (Nasdaq: AMZN) deserved its high valuation a year ago as they now seem sure it deserves its comparatively low valuation today. The concept of owning a "dot-com portfolio" sounds laughable, at present; you must be a yahoo if you own Yahoo! (Nasdaq: YHOO). But doesn't that indicate a good time to be looking to buy?
To sum up, your expectations determine your reactions. And your reactions determine your next actions. So I say set good expectations and lead the good life. "Good expectations" mean something different for each of us, so I won't presume to speak here for anyone. I'll just remind you of what happens to your head when you think you're staying in a five-star hotel... or what can happen to your investment portfolio when you go in expecting five-star returns with five-star comfort. The world doesn't work that way.
It's really more of a prison, isn't it?
David Gardner, January 3, 2001
P.S. Help make others' lives more pleasant by contributing to Foolanthropy 2000! There are only three days left in the fundraising drive, so act now!