Streetwise

Lauren Rudd

Sunday, November 3, 2013

As You Gaze at the Tea Leaves of Wall Street...

As you gaze intently at the tea leaves of Wall Street in an effort to ascertain what lies ahead, keep in mind two principles that can help guide your thinking. The first is that the performance of individual securities is uncertain and the second is that the performance of a portfolio of securities is uncertain in the short-term.

Although no amount of prose can counter the emotions resulting from a loquacious pundit discussing a day's tumultuous activity on the Street, try to keep in mind the wise words of Lucien O. Hooper, a Wall Street legend.

"What always impresses me," he wrote, "is how much better the relaxed, long-term owners of stock do with their portfolios than the traders do with their switching of stocks. The relaxed investor is usually better informed and more understanding of essential values; he is more patient and less emotional; he does not incur unnecessary brokerage commissions; and he avoids behaving like Cassius by 'thinking too much.' "

Being relaxed should not be confused with being complacent. You need to monitor your investments. Expect and react to change. No market is static, and there are no stocks that you can own and forget.

This does not mean you should move in and out of a stock every time there is a gyration of a point or two. If you continually try to beat the market in that manner then you are gambler and like any gambler you will eventually lose.

Too often investors' attention is shifted away from investment research among quality stocks, focusing instead on opinions relating to market trends. Individual stocks can rise in a bear market, and fall in a bull market. You should be buying undervalued stocks--not the opinions touted by magazines and newsletters.

Of course it is an arduous task to buy when everyone else is selling or has sold. It takes super-human resolve to invest when things look grim, to buy when the so-called experts are telling you that the outlook for stocks in general, or for a particular industry, or a particular company, is uncertain.

But if you purchase the same securities as everyone else then you will have the same results as everyone else. By definition, you cannot outperform the market if you buy the market. And chances are if you buy what everyone else is buying, you will do so only after it is already overpriced. Bernard Baruch, adviser to presidents, was succinct when he said, "Never follow the crowd."

Many investors live in fear of an investment not working out. Consider the following example. Invest $20,000 in each of five investments for twenty years. Assume the first investment is totally lost and the second investment returns only the original $20,000 investment.

Assume you receive an annual return of 5 percent on the third investment, 10 percent on the fourth, and you hit a home run and receive 15 percent on the fifth $20,000 investment. If you do the math, you will find that after the twenty years, you will receive back a total of $534,946.

If instead of splitting the $100,000 up into five parts, assume you invest the entire $100,000 in a risk-free 20-year Treasury bond paying 3.33 percent. What would you have at the end of the twenty years? The answer is $193,579. Even with a complete loss of one fifth of the total earning power, and a zero return on another fifth, the performance of the diversified investment won out. Not every investment has to work out, but you must be adequately diversified.

Wall Street's world is fragile, and depends extensively on time and chance. So invest with intelligence, engage in solicitous but sensible discourse when considering the future, diversify your assets, and finally be skeptical about every prognostication you are given, including mine.