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Playing with Numbers, Part 2

By Brian | September 28, 2006 | Share on Facebook

The Dow Jones Industrial Average traded briefly over it’s record high today, while the tech-laden NASDAQ Composite remains significantly less than half of it’s record high. In keeping with today’s trend data theme, here are some interesting comparisons:

Here’s the graph everyone always talks about – stock market performance from the time the bubble burst (early 2000) until today:

The Dow broke even today (2,449 days after it’s record high). The NASDAQ is still down almost 50%. This data has been used for everything from explaining away bad investment strategies to arguing against the privatization of social security.

But let’s look at two other graphs that may put things in perspective. First, the performance of both indexes over the last ten years:

Obviously, the first thing one notices is the 377% gain in the NASDAQ between 1/1/96 and 3/10/00. But let’s focus on a few other data points as well: First, note that the NASDAQ’s net gain from 1/1/96 to today is 112% (just over 10% per year), which almost equals the more conservative DJIA’s 124% gain (11.5% per year) in the same period. Second, note that at the NASDAQ’s lowest point, 10/9/02, it was still 5% above it’s value on 1/1/96. Finally, note that Alan Greenspan’s famous “irrational exuberance” speech, in which he warned that assets may be overvalued, was given on December 5, 1996, when the DJIA was 6,381.94 and the NASDAQ was 1,287.68 (both roughly half of what they are today).

And yet, the same sorry tale continues to resonate over many beers in many different Wall Street bars: You invested $1,000 in a NASDAQ index fund on 1/1/96. On 3/10/00, it was worth $4,769. On 10/9/02, it was worth $1,052. Although you’d made 5% on your money (a paltry 0.75% per year, but still a gain), you cried to your friends about how you’ve lost your life’s savings. Now it’s 9/25/06, and your original $1,000 is worth $2,124, representing a very respectable 112% gain (more than 10% per year). Still, you cry to your friends about how risky the market is because your portfolio isn’t worth $4,769 like it used to be.

One more graph to illustrate another subtle point. By the end of 2002, the NASDAQ was significantly behind the DJIA, but today they’re just about even. The graph of both markets since 1/1/03 looks like something out of 1999. Well, OK, 1998:

A 62% return from the NASDAQ (16.5% per year), as compared to 34% (9% per year) for the DJIA.

The bottom line: the last ten years have been a roller coaster in the market, to be sure, but at the end of it all, total returns have hovered around a nice, healthy 10% or so. The volatility in between means that some people got lucky and made a killing, and others got unlucky and got killed.

But everyone remembers the lofty peaks, and the psychological loses are much, much harder to make back than the financial ones.

Topics: Money Talk | 5 Comments »

5 Responses to “Playing with Numbers, Part 2”

  1. Jeff Porten says at October 3rd, 2006 at 5:52 pm :
    Let’s put this in terms Jeff can understand.

    You go to Las Vegas, and get a hot shoe at the blackjack table. An hour later, you’re up enough money to pay for your airfare.

    You move to video poker, hit a royal flush, and now you’ve paid for your hotel and meals.

    You take that to the craps table, and after a hot streak, you’re up enough money to go home and buy a MacBook Pro with the house’s money.

    Then you start drinking heavily and betting black chips, and by the end of the night you’ve got enough left over to buy a nice steak dinner and that’s it.

    You eat your steak dinner. Are you up a steak? Or down a MacBook Pro? 99% of gamblers would consider themselves three grand in the hole.

  2. Brian says at October 4th, 2006 at 1:16 am :
    99% of gamblers would consider themselves three grand in the hole.

    Well, 99% of gamblers would be wrong, but not as wrong as most investors. In the gamblers’ case, the proceeds were liquid at all times (cost of changing chips back to cash = $0). So they actually had enough for the MacBook Pro at one point.

    Investors had paper profits, which only became theirs if they chose to sell, which many of them did not.

    All of which is a little besides the point. In gambling, you’re playing for the short term win. In investing, you’re putting your money somewhere & hoping for a good return over time. When that good return comes, fretting over the path that got you there is somewhere between sour grapes and a poor understanding of investing.

  3. Jeff Porten says at October 4th, 2006 at 7:50 am :
    True story: I was once on a date that went very badly after I burst out laughing when she complained about the drop in her NASDAQ portfolio, heavily centered on her dot-com options.

    Her: That’s awfully insensitive. This is my retirement!

    Me: You’re twenty-five!

    Call this the first time in Red and Blue blogging history that Brian and Jeff are totally in agreement. Alert the media. It’ll probably never happen again.

  4. Dean says at October 5th, 2006 at 10:32 am :
    The problem comes because many, many people didn’t buy NASDAQ stocks in ’96. They bought them in ’99, or early ’00. I know a number of people who took major baths, including one guy who bought Nortel when it came down to $25. I think he lost $300,000.

  5. Brian says at October 6th, 2006 at 1:56 pm :
    Yes, Dean, but also, many people bought NASDAQ stocks in 2003. I know some folks who have done quite well, including one guy who bought Google when it was down at around $180. I think he made $300,000.

    I’m being a little facetious, of course, but here’s the point: in any market at any time, if you get in at the peak and get out at the trough, you take a major bath. If you stay in for the long term, you do OK (especially if you diversify and dollar cost average).

    For example, if your friend held on to his Nortel (which doesn’t trade on the NASDAQ, btw – maybe you meant Intel?), he’s already made back something like $150,000 of the $300,000 he lost.

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