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Investor Psychology

Look Ahead, Not Behind

Don't obsess about last year's big fund winners or stocks that soared 400% in six months.

Investing through the rearview mirror is one of the worst mistakes we make. Most investors tend to view the recent past and reflexively extrapolate that a trend -- any trend -- will continue. A hot fund will stay hot. Soaring fertilizer stocks will reach the sky (with the help of -- what else? -- fertilizer). Financial stocks will languish forever.

This tendency can be harmful to your wealth. It turns many people into de facto momentum investors, although most would deny it. They'll say they're not buying a stock because it just went from $10 to $100 but because the future looks so terrific. Of course the future looks terrific. That's why the stock just went up 900%!

So how can you fight the temptation to believe that the past is automatically prologue? With logic, math, self-knowledge and some contrarian thinking.

Math matters. When Cisco Systems' market value nearly hit $600 billion in March 2000, anyone with a sharp pencil should have known it was a sell, not a buy. Why? Because Cisco was too big to justify a share price of 150 times the previous 12 months' earnings.

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It would have had to earn $20 billion to $30 billion a year, after taxes, to justify its market capitalization. Cisco has kept growing, but over the past 12 months it made only $7.7 billion. Small wonder the stock, at $26 in mid May, is two-thirds below its record high.

Avoid temptation. Don't obsess about last year's big fund winners or stocks that soared 400% in six months. You'll drive yourself crazy and, more often than not, lose money. The more you kick yourself about missed opportunities, the more likely you are to pile in at the top.

Remember cycles. Almost all stocks respond to current and expected economic conditions. In an essay titled "You Can't Predict. You Can Prepare," Howard Marks, chairman of Oaktree Capital Management, mocks economic forecasting. But that doesn't mean he ignores the economic cycle. "So how can non-forecasters like Oaktree best cope with the ups and downs of the economic cycle?" he asks. "I think the answer lies in knowing where we are and leaning against the wind."

That doesn't necessarily mean loading up on Citigroup today because you know it is down and despised, but it does probably mean that some financial stocks are at least worth a look. The overall stock market typically bottoms six to nine months before the economy does, but millions of investors find it hard to buy when the news is terrible and likely to stay that way for months. Often, however, it's the right thing to do.

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Don't be scared by strength. Stocks often rise for good reasons. So it makes no sense to avoid, say, a Google at $150 or a Potash Corp. of Saskatchewan at $60 simply because they've soared recently (each is now trading for three to four times more). But buy them only when you're convinced that the market is underestimating their future growth.

The key is this: You should be aware of the recent past, but you should not be swayed by it. When making an investment decision, always make sure you have a clear-eyed view of the road ahead.

Update. Communicate.com (CMNN.OB), now known as Live Current Media, is up 39% since I praised it in the March issue. I like it even more now. The company has signed an exclusive ten-year deal to handle online content, advertising and merchandising for the DLF Indian Premier League, a new Indian cricket league. In its first week, the new Web site generated 2.25 million unique visitors and 10 million page views. The new league plays a faster, more exciting type of cricket, and matches feature laser shows and loud music. The league has been attracting large crowds and many of the world's top players. Live Current Media is now thinking of turning its Boxing.com domain name into an active Web site, perhaps with a partner.

Columnist Andrew Feinberg writes about the choices and challenges facing individual investors.