Kim Snider
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October 01, 2006

Dow components compared to all-time high

I am on a plane, en route from Dallas to Atlanta. CNN was reporting the Dow was within just a few points and inching closer to its all-time high as I was getting on the plane. By now, it may even have reached or surpassed it.

 

We know stock prices rise over long periods of time. We also know, from studies like those done every year by Dalbar, that investor returns seriously lag investment returns. For example, in the 20 year period ending in 2003, the S&P was up almost 12% per year, on average. The average investor was only up 2.7%.

 

Using the Dow as an example, it is easy to see why investor performance is so bad. The Dow made its previous all-time high on January 14, 2000. Mike Panzner has gone to the trouble of calculating the change in the current stock price of each of the Dow 30 stocks from the January 14, 2000 high to now.

 

Dow Components

Dow_components

 

These numbers point out two places where our brains are likely to tell us the opposite of what we need to know or do to be successful investors. The first is the trickery of averages and the second is the trickery of indexes.

 

The financial services industry uses averages a lot! You almost can't help it. It is a convenient way to summarize information. The problem with averages is that people hear them and assume they will be at least average. Most people assume they will be above average. Some of them will be right. But some won't. Someone has to be below average.

 

Everyone wants to be in the top half. If you are part of the bottom dwelling contingent, you think the investment sucks - there is something wrong with the investment or you're somehow getting gypped. Of course, If you are part of the group who is doing better than average, you think it's the cat's pajamas.

 

The danger in averages, or at least in everyone's desire to be above average, is that when you are not, you head for the exits. You bail out of the investment you are in, hoping to replace it with something better. But again, someone has to be below average. Whether you end up in the top half or the bottom half of the next investment is just luck.

 

If you end up in the bottom half again, you sell and look for something else. You are creating a pattern of buying high and selling low. If you end up in the top, then someone else is now in the bottom and they will sell low so they can go buy something else high. Every time you move from one investment to another, rather than increasing your odds of success, you mathematically increase the odds that you will underperform.

 

Crazy, huh? But true.

 

The other interesting point is made by the individual Dow components against their January 14, 2000 prices. More stocks in the Dow are lower today than are higher.

 

Contrary to the conventional wisdom, rising tides don't float all boats. The opposite is also true, falling markets don't sink all boats either. This is due to the random nature of price movements.

 

I think most people assume that if the market is going up, their stocks should go up too. I will concede that the bias is toward up in a rising market and down in a falling market. But that's about it. Stocks move in their own cycles within the movement of the index and often in the opposite direction.

 

This idea is critical to the way I invest. I believe stock prices are random. I know that even financially sound well run companies, including Intel, Microsoft, Coca-Cola and Wal-Mart, can experience five year periods of negative returns in a rising market.

 

So the Dow points out what I believe are two critical success factors for investors:

 

1. You have to resist the urge to jump ship every time an investment doesn't feel good. Chasing performance leads to worse performance. The patient investor always wins out over the impatient one.

 

2. When evaluating investment strategies, look for something that recognizes you will be impatient and makes staying in easier, even when the investment isn't up on a total return basis. For me, that means creating an income stream I can use to pay my bills and maintain a comfortable standard of living whether my stock prices are up or down. I am comfortable holding good companies for very long periods of time, so long as my standard of living is unaffected.

 

UPDATE: I wrote the majority of this post on Thursday. I didn't finish it until Sunday. So we know the Dow backed away from the all-time high. But the point remains.

 

SOURCE: Comparison of Dow components is from The Big Picture. Thanks Barry. I looked for the original source from Mike Panzner to give him a link. I couldn't find it.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

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Kim Snider is an author, speaker and host of Financial Success Coaching, Saturdays at noon, on KRLD Newsradio 1080, Dallas - Fort Worth. This blog is primarily devoted to empowering individual investors with information to help them be good stewards of their money. Above all, it is about achieving true financial success. Kim's book, How To Be the Family CFO: Four Simple Steps to Put Your Financial House in Order is in bookstores now. Order yours from Amazon or other fine booksellers today.

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