High on Highs

When it comes to investing, breaking-even is not something to be celebrated. Especially if you only manage to do so by ignoring some important, but maybe not obvious, costs. Rejoicing as various stock market indices pass previous high points exposes a flaw in the mainstream attitude to investing.

If I bought a diversified portfolio of stocks such as the S&P500 index in October 2007, I would have broken even in March this year. Reading articles (like this) related to this point may give me a sense of achievement or at least alleviate my sense of having made a terrible decision (more on this in a future post). But I would be ignoring the fact that I have put capital at risk for five and a half years with nothing to show for it and that the money I have now is worth less, in terms of what it can buy, than in 2007.

Unfortunately, the break-even mentality prevails among amateur investors over the slightly less tractable but more correct view reflecting risk and opportunity cost. The break-even mentality resonates more with a gambler’s than an investor’s.

We don’t actually know when the stock market hits a new high in the “real” sense. To get an idea we would take the previous high and assume it grows at a rate of return commensurate with the perceived risk over the relevant time period. For the sake of argument, let’s say the required rate of return is 6%, applying it to the October 2007 high of 1565 in the S&P500 index gives a value of north of 2150. But you could also argue that the market was over-valued then, in which case there’s little merit to using it as a reference point anyway.

In short, viewing the stock market as a means of gambling is not a desirable state for anyone concerned and talking about new highs is only encouraging that attitude.

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