That day, Federal Reserve Chairman Alan Greenspan unexpectedly lowered the federal-funds rates by half a percentage point, and the stock markets surged, with the Nasdaq posting its largest gain ever, 14.17 percent. The Dow Jones Industrial Average, meanwhile, climbed a healthy 2.81 percent and the Standard & Poor’s 500 Index gained 5.01 percent. Tom Gardner co-founded The Motley Fool (which provides content to MSNBC.com) in 1993 as a multimedia financial education company whose mission is to “educate, enrich and amuse individual investors.” NEWSWEEK’S Laura Fording asked Gardner for his take on the rate cut and for a bit of advice about investing in 2001. Here are some excerpts:
NEWSWEEK: What do you make of Greenspan’s move to lower interest rates?
Tom Gardner: It’s a surprising and a substantial move by the Fed. First, it happened between [Federal Reserve] meetings; many investors probably did not realize that could happen. Second, it was a one-half-percentage-point move. So it has to signal that the Fed saw a greater potential for recession and less capital in the marketplace than it was comfortable with. For an investor, it generally means good things in the short-to-intermediate term. Statistics show that when the Fed makes one move, the next two or three rate moves tend to go in the same direction. I think the market looks at this as a positive development, but I don’t think it should change [the perspective of] average investors looking at their 401(k) or investment plans.
Does this change any advice you might give?
Interest rates have a very meaningful effect on what happens in the market. The Fed is trying to provide more access to capital for companies. So investors have to track the dollars to determine which companies will benefit most. I think those are the same companies who were going to do well even without a rate cut. In other words, believe it or not, I think this is a nonevent. Although I understand that in the short term it’s substantial, looked at over time, interest rates will rise and they will fall.
So this won’t necessarily have a long-term effect on the economy.
It depends on how you define long term. I think that over the next two years, it could have a significant effect on the market. It could signal that there will be capital for small companies to start up, if they need to borrow money, and it will affect individuals in terms of how they use capital. But I don’t think it fundamentally changes the five- to 10-year outlook.
Do you think the rate cut could help prevent a recession?
Yes I do. It definitely has a meaningful effect. But I don’t think investors should change their approach based on where rates are going. I just don’t think anyone can consistently or accurately predict the direction of the interest rate. So I don’t use it as a defining factor in my investment approach.
What advice would you give a person who bought tech stocks high, saw them bottom out and now sees an increase in value?
If you didn’t actually sell and there’s a nice little bump up… then you got lucky. But ultimately, if you are not digging in and you are not interested in thinking about how a company operates, then I suggest indexing…
Do you think Greenspan’s decision was politically motivated?
Too speculative to tell. I’ve read and I understand the speculation that he’s trying to make it clear that Fed policy is the governing factor here…
Do you think Bush’s tax cut plan becomes more attractive given the rate cut and the market’s response?
I think it becomes slightly more attractive, because it is an indication, on some level, that the Fed agrees there needs to be more capital in the marketplace. And another way to achieve that is to have a tax cut. I don’t mean to suggest that Greenspan supports that tax cut. I think it’s an indication by the Feds that recession is a possibility. Bush may be able to use that to persuade the general public and Congress to actually follow through with the tax cut… I don’t think a tax cut is coming as quickly as people might think. We have a very divided Congress.
Do you have any predictions for the upcoming year?
I think investors will continue to be forced to reevaluate what it means to invest. The market has become very volatile over the past couple of years in the United States, and I don’t expect it will stop. A lot of individuals are going to have to look at their retirement plan and ask themselves, “Is it really a retirement plan or a trading portfolio?” If it’s a retirement plan, they are going to have to train themselves to think in five- or 10-year spans and to look past the emotion of the day, which I think has really ruled the market over the last couple of months and has caused a lot of people to lose sight of their core strategy.
Do you think many people use their retirement plans as trading accounts?
I don’t think it’s really happening in 401(k) plans. I think there’s a lot of active trading going on in IRA accounts. That’s because there isn’t a tax consequence of doing so…. People are becoming more cognizant that active trading outside of a tax-deferred account is particularly painful. It’s going to be painful for mutual-fund investors who didn’t realize they were active traders by holding particular funds that, even though that fund was down for the year, will unfortunately deliver them a capital-gains tax. I think they’ll realize that, at best, by trading that actively, they will underperform the market’s average by the amount of money they pay out in commissions from making those trades…. I think the average trader, over the short term, will do no better than what the market does, less the commissions they pay.
What financial resolutions would you encourage people to make for the new year?
The most important is to get rid of all that high-interest consumer credit. We’ve had tremendous credit expansion in the United States, a lot of borrowing to buy. A lot of folks need to ask themselves whether it’s mathematically logical to carry $3,000 worth of credit-card debt at a 15 percent interest rate along with investment accounts or even 401(k) plans. I think they’ll find, more often than not if they are really doing the fifth-grade mathematics, that they can’t [offset] that interest rate they pay out on their credit card [with gains they receive from their other investments]. So start making more than those minimum monthly payments and make a phone call to your company to renegotiate for a lower interest rate.
Any other resolutions?
Investors, I think, need to really understand what they own. Over the last few years, a lot of new investors, as well as some old investors, have made some decisions that represent moves beyond their circle of confidence. They’ve invested in a fuel-cell technology company, say, without really understanding what fuel-cell technology is. So I think getting back to core strengths is a great resolution for a lot of investors.
Do you recommend index funds?
Index funds are broadly defined. Increasingly, we can index off just about anything. But I am a very strong proponent for the total-market index fund…. I think having a total-market index fund and consistently adding money to that fund is the best first step for most investors and the best last step for many.
Why?
One, you have all the diversification you need. You have 10,000 companies. So if you are worried about only being in one fund, you have such diversification within that fund. Two, it only charges two-tenths of a percent a year, while the average [professionally managed fund] charges about 1.5 percent. Over the 25 years of the popularization of the mutual fund, the vast majority of professionally managed funds have done worse than the average rate of return of the overall stock market. So you’ll get better return at lower costs and total diversification.
What are the some of the foolish choices people make, especially in volatile times?
I think acting hastily has to be number one, [for example] selling a great company because the price has moved down significantly, without really evaluating if something consequential has changed in the company’s business or if it was just wild market fluctuation. [Or] buying more of a loser without really evaluating whether the business holds promise.
What would you say to people whose investment strategies aren’t paying off as planned?
I’d remind them that this is a lifelong endeavor and that the great rewards are over 25-year periods. It can be incredibly intellectually satisfying to understand more about the business world and the world around us. And that means, I think, abandoning short-term reactionary mode and being a long-term student of the game.
Do you think online trading sites will get less use if the market isn’t doing as well? I doubt people enjoy tracking negative numbers all day long.
I think that people will be much less inclined to follow their portfolio on a daily basis if they are taking a beating….
Are any sectors looking good for the coming year? What do you think about biotechnology?
It’s difficult for me to predict what will happen over the next 12 months, it’s too short a time period. From a longer-term perspective, I think one of the great opportunities facing all of us as investors is biotechnology. There will be three different ways to invest in biotechnology at a very general level. The first will be to invest in what will be known as biotech index funds. They are known right now as biotech holders on the American Stock Exchange. They allow you to buy a group of biotech companies or buy the entire sector…. The second way is to actually go and do a tremendous amount of research to learn about these companies. Overlay that with a lot of financial knowledge… and then begin building out a biotech stock portfolio. The third way is speculating without doing very much research, and I think those people will do worse than those who picked the first strategy of just the index. For five years and longer, biotechnology, I believe, will have much more profound implications for our lives and for our investments than the Internet did over the last 10 years…. I don’t believe dotcom is over, but if you are a rulebreaker investor who wants to look for an America Online, the America Online of the next 10 years, I believe, is in biotechnology….
What about alternative energy?
Energy is fascinating. There’s a huge infrastructural cost to innovation in energy. So if you take the world of fuel cells, for example, there’s a lot of hype about all of us driving fuel-cell powered automobiles. But in order to do that you have to have an incredible investment…. I think there are great opportunities there, but for someone like me, who knows very little about it, I would be inclined to try and index there. I think many more significant up-front investments need to be made before those are really commercially viable.
Any comment on pharmaceutical companies?
If you look at the way the Internet developed [purely online vs. traditional companies launching online ventures] there will be a lot of pure biotech companies that fail. There will be a lot of me-too companies that didn’t really have a long-term game plan and didn’t feel any real responsibility to their shareholders. There will also be great pure biotechnology plays, and there will be the equivalent to the bricks and mortar [of the Internet world], the pharmaceutical companies, which have a lot of money and have reasons to not want biotechnology to innovate too quickly, but also have an interest in being an investor and a developer in that world.
Any types of investments that you think are better to stay away from?
First, penny stocks. Never invest in companies under $5 a share. Seventy-five percent of them go bankrupt every 10 years. Second, don’t trade options. The vast majority of people, according to Peter Lynch [author of the book, “One Up on Wall Street”], lose money when they make option trades. They don’t just lose to the market – or make money but less than the market average – they actually lose money. Third, seriously reconsider active trading, day trading or multiple trades per month. You are only destroying the greatest benefit to the individual investor, which is compounded growth, uninhibited by commissions, taxes and emotion.
Any advice for those who bought tech stocks before the bubble burst?
It depends on what the stocks are. But if they feel they can’t evaluate whether the stocks are good or bad, I would be inclined to have them sell and endure the pain of having lost perhaps half of an investment. [It] represents a tuition payment on their part, toward learning that if you are going to invest in individual stocks, the only opportunity for success over time is to really understand the businesses behind those stocks…. If you’ve had a foray into individual stocks, and you’ve had bad performance and don’t really know what to do, generally that means to me, get on the index train, unless you know at some point in the future you can make intelligent evaluations of individual companies.
Any New Year’s resolutions for the Motley Fool?
To really see things as they are. It sounds very bland, but if I look at a lot of Internet companies, I don’t think they really asked themselves why they were doing what they were doing.
