A 500 Point Tale

DAVOS/SWITZERLAND, 25JAN07 - Maria Bartiromo, ...

DAVOS/SWITZERLAND, 25JAN07 – Maria Bartiromo, Anchor, CNBC’s Closing Bell, and Host and Managing Editor, Wall Street Journal Report, CNBC, USA; Young Global Leader captured during the session ‘What’s on the Mind of Asia’s New Business Giants?’ at the Annual Meeting 2007 of the World Economic Forum in Davos, Switzerland, January 25, 2007. (Photo credit: Wikipedia)

A 500 Point Tale

“Drop A Zero From The Dow”

As the market closed down today, August 10, 2011, roughly 520 points I was somehow transported to a different place and time.  I was transported to October 19, 1987.  I don’t know what triggered the reaction but as I watched the 4:00 P.M. market close and Maria Bartiromo from CNBC give us her patented concerned look of imminent doom while still appearing empathetic and caring the headlines read “Today the market had the 9th worst day in stock market history.”  I was right back to October 18, 1987, my first day as a registered representative.  The market closed down 508 points on that day and on that day it was the “Worst day in stock market history.”  On that fateful day the markets experienced the worst percentage sell-off or loss ever as well as the worst point drop ever.

I don’t know why my mind zeroed in on this parallel but it did and upon reflection I realized that what I was feeling was financial deception.  I couldn’t determine if it was on purpose which would be insidious or an accidental reflection of our times and how we measure the market.  You see the market went down, 4.62% today instead of 22.62% like it did on October 19, 1987.  Ever curious, I then downloaded historical data and ran a simple analysis to determine the gravity of today’s decline from 1928 to the present and what did I discover?  I found out that in fact we didn’t experience the 9th worst day in stock market history but the 90th worst day instead.  The news I heard today was 1/10th as bad as the reality.  I started to think about a world where there is a 10 for 1 Dow Jones Industrial Average split.  Instead of the Dow Index at 10,000 or 11,000, it should be split 10 for 1 to 1,000 or 1,100.  This would relieve so much stress it would be hard to quantify.  The effects on the market would be even harder to quantify.

If we asked the sophisticated folks at Dow to implement this simple adjustment to their calculation I believe we would dampen volatility which would reduce the behavioral risk associated with regular folk investors that panic during situations like today.  I suspect it would detract form the attention paid to volatility and might restore or re-ignite a sense of invest for the long term amongst us.  Nothing else would have to change—just drop a zero from the Dow as is the subtitle of this tale.  How different would today’s and tomorrow’s headline read, and more importantly how differently would people react, if instead of “The market has the 9th worse loss in stock market history as it plunges 520 points” which to me is an intentional and self-promotional interpretation and harmful to investors, the headline instead was “The market dropped 52 points today over growing concerns about European banks.”

I write these tales because I want you to think, and take control of your senses and emotions.  I have maintained throughout that behavior is the greatest obstacle to success as an investor.  But I feel for you.  You are constantly being subliminally bombarded with information that makes you want to act irrationally.  Don’t do it.  Train your mind.  Avoid the pundits and purveyors of fear.  Focus on the percentages and not the points.  If you get angry enough raise a stink—but most importantly—always look at investments from a percentage perspective and not a dollar or point perspective.  In An Absolute Tale I talk about the danger of looking at your portfolio in terms of dollars instead of percentages.  In this tale I want to emphasize the need to also focus on percentages instead of points.  I know the folks at Dow and the media have a vested interest in keeping the Dow index in the 5 digit range and someday in the 6 digit range, but this doesn’t mean you must be their behavioral patsy.  Always assess the situation for what it is instead of what they tell you it should be.  Then use your common sense, sound judgment and look at percentages.

A look at the following table might shed some light on what has happened a year after there has been a drop of at least 4.62% in a day.

An Analysis of the Dow 1 Year Later

As always, these tales are not meant to give actionable advice but instead to provide a framework from which to think.   The table above is not actionable advice and if you read A Mining Tale you will understand why.  Nevertheless, if every time the market dropped at least 4.62% you bought at the closing price that day you would for the most part be extremely happy 1 year later.

Can we make any inferences from the table above?  Here’s one—as the Dow has climbed in terms of points and there has been an exponential increase in information and concerned and empathetic fear-mongering the days of large moves down increased as a function of poor behavior and the subliminal suggestion.  Is it a valid inference?  That’s impossible to determine.  But as a serious investor that cares about their future you better focus on reality and reality is measured in percentages.

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5 Comments

  1. Pingback: Newly Released Financial Tale – A 500 Point Tale | Financial Tales

  2. Great tale about keeping it all in perspective. I figure that I put my plan together for the long haul, ignoring the ups and downs of the market, and if I fail to execute on the plan because of the doom and gloomsters on the news, then I’ve failed. I just keep investing slowly and steadily, and trusting that long term trends will continue.

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