This column first appeared on June 9, 2004. It has been updated.
In June 2003, I wrote an article advising you to ignore a few market-timing bears who'd crept out of the woods following a five-month 12% rise in the S&P 500. A 12% rise, mind you, that was fresh on the heels of a 23% loss in 2002.
My column was inspired by a Washington Post article titled "Investors Decide to Run With the Bulls: With Economy Shaky, Some Analysts Whisper 'Irrational Exuberance.'" The Post quoted several skeptics who generally derided us small investors for buying into an overvalued market that was ripe for a fall. Part of their argument centered on a historically high price-to-earnings ratio for the S&P 500, which was above 20 at the time.
However, 17 months after the article appeared, the Dow and S&P 500 are up roughly 15% and the Nasdaq has gained 25%. And guess what? The market's P/E has actually contracted to below 20 during that period.
So what?
I bring this up not to say "I told you so," because I didn't. As I explained then, I had no idea where the market was going in the near term, and neither did anyone else. Instead, I'm calling this to your attention to remind you of a basic Hidden Gems investing tenet: We buy companies with the intention of holding them for a very long time. Stories can change, of course, and we may very well sell after a short period. It happened with Talk America (NASDAQ:TALK), which Tom Gardner sold at an 18% loss after just eight months -- one of his few disappointments on the way to 37% average annual gains for all his Gems selections since he began piloting the newsletter in July 2003. (Yes, just after the Post article appeared.)
Over your investing lifetime, you'll have several losers and several marginal winners. If you've chosen well, however, you'll also have a small handful of massive, multiyear outperformers, and if you follow the "buy right, sit tight" strategy and hang on to those winners, your chances of significantly beating the market are greatly enhanced.
If you've sworn off individual stocks and invest only in an index fund, you have even more reason to ignore the pundits and gurus trying to scare you out of the market. As I've said before, it's perfectly valid to discuss the valuations of Lucent (NYSE:LU) (up 60% over those 17 months) or Intel (NASDAQ:INTC) (down 14%). But the total market is a different issue entirely. Are there really silver linings behind the dark clouds at Merck (NYSE:MRK)? Great question, and one we've tried to answer. What about the valuations of IBM (NYSE:IBM), Pfizer (NYSE:PFE), and Cisco (NASDAQ:CSCO), which have underperformed the S&P during that time? Good discussion. Is the market due for a short-term pullback? Bad question, because no one can consistently time the market.
Take a look at this logarithmic chart of the Dow Jones Industrial Average from 1929 to the present. It beautifully points out both the risks and rewards involved in stock investing. It's hard to pick a random point that does not see the chart higher 10 years later, and, of course, the entire 75-year period shows average returns of about 10% per year. Still, nothing is risk-free, and those who first entered the market with a lump sum in 1929 had to endure many years before they earned back their principal.
And yet, as Benjamin Graham pointed out in his classic The Intelligent Investor, a person who began dollar-cost averaging into the market in 1929 would have earned more than 8% compounded annually by 1948 -- despite the fact the Dow's value fell from 300 to 177 during that period!
Invest through thick and thin, dear Fool. Don't bother timing the market.
Different paths to victory
Tom recently told his Hidden Gems members that he fully expects -- years down the road -- to meet some of them who hold as many as 40-50 different small-cap stocks that they found in the pages of the newsletter. Dollar-cost averaging. Consistently buying. Holding. Some may wind up like the legendary Shelby Davis, owning hundreds of stocks worth millions of dollars.
Don't let that scare you. Although a fine way to invest, that type of diversification isn't for everybody. Perhaps you'd rather own very few stocks at any one time -- similar to the Warren Buffett punch card strategy. That's valid also, especially for the more experienced.
If you need good stock ideas, Tom has a no-risk, free-trial offer for Hidden Gems. But whatever your preference, we encourage you to start investing if you're not yet doing so and to continue investing if you have. Years down the road, you'll be glad you did.
Rex Moore will write for food, preferably donuts. He works with Tom Gardner digging for Gems, but owns no companies mentioned in this article. You can visit his profile and the Fool's disclosure policy.
