What does today's alleged news that more cash flowed into stock mutual funds in the last three months than at any time since 2000 have to do with dieting?
Well, we all know that the best way to lose weight is gradually by eating fewer calories and exercising more. Yet, to this day, people insist on practically starving themselves for periods, then follow up with explosive binges that lead to greater weight gain. It's a vicious cycle.
When investing, the best course is to dollar-cost average into low-expense, broad-market stock index funds. Or, if we want to buy individual stocks, to get in gradually, having sought out and identified decent-to-great businesses at attractive valuations. Investors, however, invariably forsake the markets when they hit rock bottom, only to binge again once things heat up.
For the less experienced who insist on buying stocks anyway, legendary value investor Benjamin Graham advised buying popular ones. Today, that might include those that make up the Dow Jones Industrial Average, including Johnson & Johnson (NYSE:JNJ), Coca-Cola (NYSE:KO), and General Electric (NYSE:GE). Graham recommended these stocks not because they are safe or guarantee reward, but because they do the least damage the longer you hold.
Why then are investors once more doing the opposite? The Nasdaq is up 45% for the year and 74% since its October 2002 lows. The S&P 500 is up 22% and a full 40% over the same periods. By all indications, individual investors are cascading into the market willy-nilly at a time of max enthusiasm, when prices are already high. In the short run, this may indeed drive them higher, but then what?
For one thing, where will more new money come from? Demand will falter, the tide turn, prices fall, and eventually investors will desert in despair. In the days when anyone knew what an odd lot was -- an order for fewer than 100 shares (a "round" lot) -- an increase in odd-lot orders alerted the pros that small investors were piling in and that a market top was at hand.
A loser's game. As my colleague and friend Bill Mann points out this week, no one knows what the market will do next year, next month, next minute. If we did, we would have looked at the market in October 2002, known that "it was low," and wagered every penny and more on market average call options or futures. Right.
What happened instead was, in our search for attractively priced decent-to-great businesses, we found many, many that were very attractively priced. That's not market timing, but it's a lot more successful than buying and selling on emotion. When we narrowed our search for our annual publication, Stocks 2003, we had no idea what the market would do. None, nada, squat. Yet most of our picks not only made money, but also beat the S&P 500 handily.
The effort, as always, was to buy growth at a reasonable price. Rex Moore's Expedia.com approached a double when InterActive Corp. (NASDAQ:IACI) bought it out. Matt Richey's Quality Systems (NASDAQ:QSII) has likewise almost doubled. Five others have returned from 30% to 186%. Even the two that underperformed -- Alliance Capital (NYSE:AC) and Hollywood Entertainment (NASDAQ:HLYW) -- are, in my opinion, companies whose businesses and stocks can outperform in the years ahead.
The lesson, however, is that Foolish investors do not predict. We analyze, balance risk and reward, and put our money where our mouths are. There are no guarantees in investing, but we individual investors should stick with what we know and forgo the starving and bingeing. Then the odds -- not the odd lots -- are in our favor.
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