I started investing in earnest in the late 1990s. I was really great at it, or so I thought.
Then the high fliers began dropping out of the sky and taking me with them. I went from feeling like a talented investor to wondering if I was actually terrible at this for missing what in retrospect seemed like such an obvious top.
Probably neither. I had mistaken a favorable environment for evidence of skill. When conditions changed, I discovered how little my confidence had been tested.
The correction was substantial. The Nasdaq Composite fell approximately 78% between its March 2000 closing high and its October 2002 closing low.1 The internet continued changing the world while investors absorbed enormous losses.
Jeremy Grantham makes a useful distinction in his conversation on The Diary of a CEO: transformative technologies can inspire excessive investment precisely because their potential to change the world is so vast. Believing in the transformative nature of a technology and paying an appropriate price for its future earnings are separate judgments.2
How do you evaluate your own results? Owning a successful company stock can reflect sound analysis. It can also reflect the good fortune of a broad market rise, a current market preference for that sector, or simply an investment one bought and never got around to trading out of before it came into favor. The return alone does not tell us which explanation deserves the credit.
Bonds offer another example. The monthly average yield on the 10-year Treasury declined from 15.32% in September 1981 to 0.62% in July 2020.3 The path was uneven, but the long decline in yields supported prices of existing fixed-rate bonds even as it reduced the income available for reinvestment. A generation’s experience with bonds was shaped by an unusually favorable starting point.
Successful companies and investments depend on conditions outside their control, and those conditions deserve a place in our risk analysis.
Saving consistently, controlling costs, diversifying, and following a disciplined process all involve decisions we can control, but luck always plays a roll.
Successful investment periods deserve examination as well as appreciation. How much came from our decisions? How much came from changes we anticipated? How much came from conditions we assumed would continue, and what happens to the portfolio if those conditions change?
We may have been skilled, disciplined, and fortunate. All portfolios should leave room for all three explanations.
- https://www.macrotrends.net/1320/nasdaq-historical-chart
- https://podcasts.apple.com/no/podcast/billionaires-warning-im-selling-the-crash-is-already-here/id1291423644?i=1000774144260&l=nb
- https://fred.stlouisfed.org/data/GS10
Bio
Eben Burr is president of Toews Asset Management. He serves as a lecturer and coach of applied behavioral finance for Toews’ Behavioral Investing Institute. He assists in training advisors to implement managed risk strategies and build an educational process for managing investor behavior. He lives in NYC with his wife, son, and lots of guitars. Connect with Eben on LinkedIn
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