A personal finance blog dedicated discussing such topics as budgeting, asset allocation, 401K, IRA, cash flow, insurance, financial planning, portfolio management, and other areas in personal finance.


Monday, March 07, 2005

My Thoughts on the Bubble

I graduated from college with a finance degree in 1996. All those years in college, we were taught how to value companies. We looked at the standard stuff like balance sheets, income statements, price-earnings ratios, working capital, and all the other gauges of performance.

I went to work for PaineWebber in March of 1997. The market was really starting to heat up and people were starting to go nuts for anything that had to do with the internet. Day-trading was becoming a big deal, giving people too much confidence in their stock-picking abilities. I started to feel that maybe I wasted my time in college!

I knew we were heading for trouble when the "analysts" on CNBC started talking about a company's price-to-sales ratios. Of course they used to P/S ratios because most of the companies they talked about had no EARNINGS. I was literally scratching my head wondering how all this could be going on.

I never purchased an internet stock. Was I tempted? Sure! It was hard not to be tempted when people were seemingly making money hand over fist. It didn't really seem to matter what they bought either, so long as it was something related to the internet. But, I refused to buy into the hype and just kept on investing through my wife's 401(k).

In January 2001, my wife's 401(k) changed managers and I started keeping track of the performance. From the date of the changeover to the new plan, it took nearly 4 years before we were back in the black from the market crash. We are only back in the black because of dollar-cost averaging.

So, what did I learn from all this?

1. Don't go for hype. Before you start investing in something, make sure you are not buying due to hype. Hype leads to emotional decisions, which are a DISASTER when investing.

2. Remember history. When a market returns 30% one year, remember that it's historical average is 10%. Therefore, you can't expect it to continue returning 30%. Everything comes back to the average (the technical term is reversion to the mean). The ride back to the mean can be very painful.

3. Forget about how well your best friend's boss is doing. You aren't in a competition for the best returns. Instead, you are investing to meet a goal like retirement, which can easily be met with a more modest 8-12% long-term average rate of return.

4. Don't lose heart!

Well, those are my thoughts on the Bubble. Take them for what they are worth.