Greed ... How Much Is Enough?
“Twenty percent a year isn’t good enough.” That’s what one investor said to me.
I guess it’s not enough when you consider that Yahoo increased 350% one year. Or that Juno increased over 100% in one day (it dropped 43% the next day, but the media failed to report that). And then there’s Qualcomm. It delivered a blistering 20-fold increase in 1999. If you’d bought $10,000 of that stock on January 1, 1999 ... you’d have finished the year with more than $200,000. So it’s easy to see why an investor would say that 20% a year isn’t enough.
Despite these headline-grabbers, 20% not only is enough, it’s attained by only a rare few. Consider Warren Buffett. Widely acknowledged as the greatest investor of all time, he has produced an average annual return of “only” 23% since 1965. If the “greatest investor of all time” barely broke into the 20% range, what can you expect for yourself? (It’s also worth noting that, in 1999, Buffett’s Berkshire Hathaway Class A stock lost 19.8%. Guess he failed to buy Qualcomm?)
The Phenomenon of ‘Expertise Transfer Syndrome’
It’s easy to focus on the daily headlines, which lately have promoted market mania and greed. If you’ve been swayed, and are thinking about abandoning your long-term investment strategy for the chance at quick profits, I urge you to reconsider. Stay focused on your financial goals instead.
That’s because ETS is a terrible thing to have and costly to cure. It’s the belief that, because you are so good at your occupation, you will be just as successful in the field of investing.
It starts like this: Joe is a physician, and because he knows the medical field so well, he buys a couple of pharmaceutical stocks. Within a short time, he notices that two of his stock picks have grown in value much more than the stock fund he also owns. “Heck, I can do better on my own,” he proclaims. So, Joe sells his stock fund and uses the money to buy some more stocks. But he soon ventures beyond the world of health care stocks, because they’ve been lagging computer and Internet stocks. Soon, Joe is invested in stocks of companies that he knows nothing about. But it’s 1999, and technology stocks are soaring. Soaring with them is Joe’s confidence level.
His portfolio is doing great. But in his desire to maximize his profits, Joe begins to concentrate his holdings in a select few stocks -- stocks he’s convinced will score big. Eventually, he’s got most of his money in just one security. By the end of the year, it’s fallen sharply in value, taking with it much of Joe’s net worth.
Think I’m kidding? I’ve just described a real person (though his name and profession have been changed). It’s such a common malady that Wall Street has a slogan for it: “Never confuse genius with a bull market.”
The irony is that Joe was doomed from the start, not because he was being greedy, but because the numbers were against him. To see how, let’s examine...
Why the Math Tells No Lies
When you complete your financial plan, either on your own or with the aid of an advisor, your plan shows you how to reach your financial goals. But if you suddenly decide to ignore this “financial road map” and opt for shortcuts to quicker wealth, failure awaits -- even if you succeed. Let me explain.
Suppose you achieve a whopping 50% return on your portfolio in just one year. The only way to accomplish this is to incur a large amount of risk. Is it worth it? The math shows us that it’s not. Here’s why.
Look at the current value of your investments. Now, increase that amount by 50%. Will your lifestyle change as a result? Probably not. If your portfolio suddenly grew from $100,000 to $150,000 or from $500,000 to $750,000 or even from $1 million to $1.5 million -- all this before taxes, mind you -- I doubt you’d quit your job. You probably wouldn’t even buy a new house, even though you could afford to. Sure, you might take an extra vacation or buy a new car, but you won’t be hiring a butler or installing iron gates at the driveway backed up by security cameras. Thus, that large gain in a year probably won’t translate itself into any substantial lifestyle change.
And one thing is certain: any strategy that is capable of gaining 50% in a year is equally capable of losing 50% in a year. So, let me ask you this question: If your portfolio were to fall by 50%, would you change your lifestyle? Probably. Probably a lot. Maybe even to the point of having to work an extra five or 10 years.
Think about that. A big quick profit does not improve your life, but a big quick loss will hurt it. Seems to me that the downside risk is bigger than the upside reward -- and that’s a bad basis on which to build an investment strategy. Instead of gambling on a 50% one-year gain, a five-year plan of steady 10% returns is far superior.
If you’ve been tempted to follow the path to quick fortune, review your plan once more and ask yourself if it’s really worth it. You’re likely to discover that it’s not.