Rearview vs. Windshield Investing

 | Dec 18, 2012 | 4:25 PM EST
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If I were to distill the single-most contributing factor to investment loss, it would be the fact that most market participants invest by looking at the market through the rearview mirror instead of focusing on the windshield. Let me start with a simple analogy: How far do you think you would get without crashing if you drove your vehicle while looking in the rearview mirror? I'd venture to guess not so far. This analogy is quite similar to one's fate in the stock market if he attempts to base investment decisions by looking backward and not straight ahead.

A quick but instructive look at market history will provide illuminating reference. For sake of brevity, I will begin with 1964. Consider the value of Dow Jones Industrial Average on the following dates:

December 31, 1964: 874.12 

December 31, 1981: 875

During this 17-year period, stocks returned absolutely nothing: $10,000 invested at the beginning of 1965 was worth $10,000 at the end of 1981. In real terms, investors lost on the decline in the dollar's purchasing power. As you might imagine, that 17-year period convinced many investors that the stock market was a lost cause. So 1982 rolls around and no one wants to invest. Why? Because of the rearview mirror syndrome. Investors were viewing the market by looking backward at the past 17 years and extrapolating the future. Consider the value of the Dow Jones Industrial Average on the following dates: 

December 31, 1981: 875

December 31, 1998: 9,181. 43

We all know of course that the above period is now affectionately referred to as the greatest bull market in the U.S. history. So what happened in 1999? You guessed it: investors again looking through the rearview mirror were convinced that stocks were the winning ticket and that the risk was not being in the stock market. That psychological furor is what ignited the Internet craze in 1999 and we all know how that ended.

Here we are at the end of 2012, 13 years after the raging bull market, and you see the behavior playing out like a well-choreographed script. More investors continue to abandon the stock market arguing that equities are no longer the value creators they once were. Here again is another set of dates for the Dow Jones:

December 31, 1999: 11,497.12

December 17, 2012: 13,235.59

We still have a few more years to go in our cycle, but it's possible that by year 2016, the Dow will sit near 12,000 as more investors continue to lose faith in equities as the ultimate creator of wealth. (As a side note: make sure you have plenty of cash to plow into the market in 2016!). Predictably, most investors will apply to rearview approach and conclude that the future return expectation from stocks will be just as dismal as in the past.

Rather, investors are urged to look ahead: the U.S. economy is slowly on the mend, corporate balance sheets are getting stronger, and most importantly investor psychology continues to remain negative. It's being lost on many that investment means laying money out today for more money tomorrow. Unfortunately, tomorrow doesn't mean the next day, month, or even year. Focus on the past and you will likely enter and exit the market at the absolute worst times. Look ahead and perhaps the future investment climate is better than it really appears to be.

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