"If you can keep your head when all about you
Are losing theirs and blaming it on you
...
Yours is the Earth and everything that's in it,
And -- which is more -- you'll be a Man, my son!"
-- From "If" by Rudyard Kipling (1909)
The best word to capture what's been happening in the market recently is panic. Pure, unadulterated panic.
The Chicago Board Options Exchange Volatility Index (also known as the "investor fear gauge") hit an all-time high of 81.17. To give this figure some context, the market is assumed to be fearful when the VIX hits 30. In other words, the market's pessimism has simply been off the charts.
I don't blame anyone for being nervous about this market -- after all, the volatility hasn't really slowed down. But this isn't the time to swear off stocks for good -- it is, however, a good time to rethink how you invest in stocks.
Buy, sell, buy, sell
This market panic has only exacerbated a trend that was already quite apparent: instant news about markets around the world, available 24/7 on television and the Internet. It's empowering, sure, but it has also helped us lose our way.
You see, somewhere along the line, we stopped investing and started trading. While that's made commission-based Wall Street brokers wealthier, it hasn't done much for our bottom lines.
It's not the first time in history we've made the mistake of overtrading. During the Roaring '20s, the turnover on the NYSE averaged around 100%, meaning the entire value of the market was traded once over each year. In 1928 it peaked at 143%, but after the Crash of 1929, that all changed; from 1938 to 1975, turnover on the NYSE was frequently below 20%.
The past three decades, however, have ushered in the age of the institutional investor -- mutual funds, pensions, and hedge funds -- and market turnover has once again skyrocketed. In 1990, NYSE turnover was still relatively low at 59% -- but in 2007, it was at 215%.
Yes, you read that right: 215%. That means that in 2007 alone, the market traded more than twice its value. And that was before Bear Stearns, AIG, Lehman Brothers, Fannie Mae, Freddie Mac, and bailout packages worth more than some countries' GDP. I can only imagine what the 2008 figure will be.
Once bitten, twice as fast
You probably don't trade over 90% of your portfolio each year like the average mutual fund does, or engage in daily arbitrage opportunities like a hedge fund, but their rapid-fire temperament naturally affects our own investing habits. Don't believe me? Consider this example from Nobel Prize-winning economist Joseph Stiglitz, cited recently in Portfolio.
Say $100 bills are put at the feet of a group of naturally lethargic people who pick up the money at their leisure. Then an energetic person comes along and decides to run around the lazy folk and pick up the $100 bills. This forces people to sprint for their money. They thus more energy to achieve the same result. "They are unambiguously worse off," Stiglitz wrote.
That's exactly what's happening in today's market, and, as Stiglitz notes, we're worse off for it. But just because this behavior is endemic in the market, that doesn't mean it's our destiny. We can choose to behave differently.
Back to basics
An investor has one key attribute a trader lacks: patience. Whether you're buying solid dividend-paying stocks like Coca-Cola
As the great investor Benjamin Graham noted, "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." The market will eventually reward the best-run companies, even as traders fight over pennies in the short term.
Trying to out-think Wall Street over the short run will leave us unambiguously worse off -- and we'll lose a significant portion of our returns in trading fees and taxes besides. But if we buy good companies at good prices with a long-term mind-set, tune out the unnecessary noise, and let the market work itself out, we will certainly be better off.
Here at The Motley Fool, we're investors, not traders. If you'd like learn more about how we practice the lost art of patient investing, the Motley Fool Stock Advisor service, led by Fool co-founders David and Tom Gardner, is a good place to start. They look for three things in a good investment:
- Reasonable price.
- Good management.
- Potential for growth.
It's simple, but it works. Since Stock Advisor launched in 2002 (another bear market), their picks are beating the S&P 500 by an average of about 27 percentage points. We're offering a free 30-day trial to Stock Advisor, so if you'd like to learn more about our patient approach -- and what our patient approach is recommending -- click here to get started. There's no obligation to subscribe.
Todd Wenning wishes The Fool a happy 15th birthday; he does not own shares of any company mentioned. Johnson & Johnson is a Motley Fool Income Investor selection. Coca-Cola is an Inside Value pick. Apple is a Stock Advisor recommendation. The Fool's disclosure policy just got its driver's permit -- you'd be wise to avoid the roads for a while.
