I am constantly amazed at how shortsighted people -- including myself -- are. So often we are guided by short-term goals, momentary pleasures, and silly little gambles. We may know better, we may praise and honor those who behave the way we wish we did, but we continue to violate the principles that supposedly guide our thinking.

Problem #1: Irrational Expectations
Part of the problem stems from our tendency to embrace irrational expectations. What annual return do you expect from your investments? If you're like the average equity investor interviewed by Gallup in December 1999, you'd say 19%. That's just insane. It's true that a few select investors -- such as Walter Schloss, who has produced an annualized return over 20% over 45 years in his private investing partnership -- have achieved such a record over time, but they are the exceptions that prove the rule. Most professional investors beat the market only by a small margin before fees-- and that margin comes necessarily at the expense of individual investors.

We should be happy to match the market, and we should be delighted when the market earns 10% annually. Warren Buffett, chairman of Berkshire Hathaway (NYSE: BRK.A), said at the annual meeting last week that 6-7% is much more likely. His partner, Charlie Munger, called the public's expectations "massively stupid." John Bogle, founder of the index fund, projects a growth rate similar to Buffett's.

Given the predictions of these respected investors and the market bloodbath since December 1999, you'd think our expectations would have diminished. Alas, no. Recent surveys continue to show that people expect upwards of 17% annually. Many people feel that returns should be even better in the future, now that the markets have dropped to a rational level.

Problem #2: Perspective
Which brings us to the second part of the problem: framing. The markets have fallen, but they have fallen from abnormally high levels to simply high levels. Stocks in general are not cheap, they just seem cheap relative to recent history. That history means nothing for future returns.

Specifically, there were plenty of "cheap" stocks last year at this time. Abercrombie & Fitch (NYSE: ANF) was one that The Motley Fool talked about a lot. At the time, of course, no one wanted to touch retail. We didn't want to buy the "cheap" stocks, since they looked vulnerable -- based on recent history. We wanted to buy the "sheep" stocks that everyone else was buying.

Now, once again there are "cheap" stocks, like Cree (Nasdaq: CREE), our Rule Breaker pick for The Motley Fool Select this month. But, hey, semiconductors are out of favor, so we shy away. It's all about oil and gas now, baby!

Here's another example of short-term thinking. Last week, Riva Richmond of Dow Jones Newswires interviewed Jeff Fischer and me about our portfolio. The interview lasted a long time. Riva's a very nice woman, and Jeff and I love to talk. Riva was comparing the Rule Breaker to the Rule Maker portfolio and commented on how much better the Rule Breaker has done recently. She was talking about the 18% gain we've seen so far this year, compared to a 20% decline in the Rule Maker and a 13% drop in the Nasdaq.

I chuckled a little, recalling how much heat we Breakers took last year, when we were down over 50%. A quick calculation revealed that, over the last 12 months, the Rule Maker, Breaker, and Nasdaq were all down about the same amount, in the neighborhood of 35%. "Wow," Riva said, "I thought you guys were doing much better."

Riva's not unusual. Even we take a look at the year-to-date numbers from time to time and give each other a high-five. There's little reason for it. A gain is a gain, but this four-month period has only a small impact on our portfolio's final, 35-year return. It doesn't even come close to making up for last year's losses. On the other hand, there is no reason to wear sackcloth over last year's performance, since it came after spectacular gains.

Problem #3: Temptation
This one's the real killer, the one that makes me shake my head at my own behavior. I'm a Buffett & Munger fan. I was in Omaha last weekend. Listening to them answer questions for eight hours at the meeting and the press conference, I was struck (as I always am) by how simple they made it all sound. It's not simple to value a company, to spot true competitive advantage, and the like, but the premises they put forth are basic.

  • Buy what you understand.
  • Avoid institutionalized thinking.
  • Don't look to the market to tell you when you're right or wrong.
  • Resist the pressure to do something you're not prepared to do.
  • Prize ethical and honest management that is not slavishly devoted to "The Street," but to shareholders.

I agree with them when they say these things, I nod my head and see the sense in it, I recognize that individual investors can hardly succeed with any other strategy. Then, in the next moment, I start thinking about how cheap soybean futures look. I wonder if MicroStrategy (Nasdaq: MSTR), infamous for excess and aggressive accounting, is low enough to be a buy yet. I revel in the uptick eBay (Nasdaq: EBAY) gets after it predicts 50% annual growth through 2005.

There are also elements of the above fallacies in the Rule Breaker strategy. We need to address the problem areas critically, honing our work-in-progress into optimal form. 

It makes me wonder, though: Why do so many of us admire people like Buffett and Munger and then fall so far short of being like them? Their messages aren't complicated. They just require the discipline to look beyond the conditions and temptations that surround us and do what we know is right for the long run.

I've seen wealth and happiness and intelligence and ethical behavior in one package, and it is Warren Buffett. I'll never be as good at investing as he, but there is no reason not to try to be.

Brian Lund has the same problem living up to his mother's ethical standards, so you know that he's got some pretty deep issues. He owns shares of Berkshire Hathaway and eBay. To see all his holdings, check out his profile. The Motley Fool is investors writing for investors.