The Stock Market Makes Fools of Us Over and Over Again

Beyond Buy-and-Hold #47

Stocks are a wonderful but nasty investment class.

Stocks are wonderful because they offer returns that cannot be reliably matched by any other asset class. Stocks are nasty because they provide that return in a manner which makes fools of all of us.

Over and over and over again.

Think of how it is that you come to excel in just about any life endeavor other than stock investing. What makes you good at driving or cooking or raising children or in your career?


We all become better over time at most things we do by developing skills over time that we did not possess starting out.

It doesn?t work that way with stocks?not at all

Say you first bought stocks in 1990, frightened that you did not really know what you were doing but hopeful that you could pick up the idea with time. For the first ten years of your stock investing career, you enjoyed amazing returns. You came to believe that you must have been a lot better at this game than you thought you were. It turned out that it all is pretty darn simple. You buy. You hold. You get stinkin? rich. What?s so tough about that?

Then in the Year 2000 it stopped working.

What were you to do? Change your approach? Change what worked for 10 years running? That makes no sense. You stuck with Buy-and-Hold.

And you lost more. And, in the event that stocks continue to perform in the future anything at all as they always have in the past, you will lose a whole big bunch more in days to come. Stocks are priced today for a 65 percent price drop sometime over the next few years. That?s going to come as a scary hit to the millions of middle-class people who invested in stocks with the thought that stocks were a reasonable choice for their retirement money.

Stocks are THREE asset classes in one

The reality is that stocks are not one asset class, but three. Stocks being sold at a fair price are nothing at all like stocks being sold at an insanely high price and stocks being sold at an insanely high price are nothing at all like stocks being sold at a fair price or stocks being sold at an insanely low price.

To get smart about stock investing, we are going to need to start distinguishing between the different kinds of stocks. The reason why you did well with the stocks you purchased in 1990 is that stocks were selling at reasonable prices in 1990. Stocks selling at reasonable prices always do well. The reason why you did poorly with the stocks you purchased in 2000 is that stocks selling at insanely high prices always do poorly.

You cannot apply the experience you gained investing in reasonably priced stocks and expect it to apply for stocks you purchase at insanely high prices. When stock prices reached insanely high levels in early 1996, a new investment class came into existence, an insanely dangerous one with little in common with the investment class you invested in with such happy results in 1990.

Stocks fool us. Over and over again. Because the nature of the stock investing experience changes as stocks move from insanely underpriced to reasonably priced to insanely overpriced to reasonably priced to insanely underpriced. It can take decades for these price swings to take place and most of us are looking to the experience we gained investing in what can fairly be characterized as an entirely different asset class for guidance on how to invest in the asset class available to us in the current day.

How do we stop being fooled?

We need to start calling the different types of stocks by their proper names. It may be that a rose is a rose is a rose but it is definitely not the case that a stock is a stock is a stock. The type of stocks available for purchase in 1982 offered a once-in-a-lifetime opportunity for the middle-class investor to get rich in a short amount of time. The type of stocks available for purchase in the late 1980s and early 1990s represented a solid long-term value proposition. The type of stocks available for purchase from 1996 forward represented an opportunity for widespread wealth destruction unparalleled in U.S. history.

It hurts to hear this. I get that.

You know what? It hurts even more to be made a fool of again and again and again. The thing to do when you discover that you have been fooled is not to fall into a funk over mistakes made in the past. The thing to do is to learn from the mistakes of the past to become a far more effective investor in the future. This economic crisis offers us all an opportunity to learn things about how stock investing works that we would have had little chance of learning any other way.

We?ll make it!

Rob Bennett argues that the normal retirement age is a changing?. Rob?s bio is here.

( Photo from Flickr by Helico )

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