By Ethan Haskel (TMF Cormend)
May 3, 2000

Three quick flashbacks, to earlier times in my life:

• As a child of eight, my father took me for a deep sea fishing trip on a boat off the Southern California coast. Once aboard the vessel, I ordered a hamburger, served with mayonnaise. The seas became quite rough that day, and I spent most of the afternoon puking that hamburger over the ship's side.
  
  
• As a freshman in college, I learned the game of backgammon, and spent the first few months idling away my time playing with friends, occasionally with some loose change on the line to keep it interesting. In one particularly memorable game, I was way ahead of my opponent, but lost when he rolled three consecutive double sixes to end the game.
  
  
• In my early medical training days, I administered a new clot-busting drug to a patient who was having a heart attack in an attempt to open up a clogged heart artery. Probably as a side effect of the treatment, this patient suffered a fatal hemorrhage into his brain.

What do these three diverse (to say the least!) life experiences have in common? They demonstrate what I'll call "the power of one." No, I'm not referring to the title of Bryce Courtenay's uplifting novel about a remarkable boy growing up amidst an oppressive South African culture. Rather, this particular power of one demonstrates how sometimes a single, often dramatic, life event can affect our future actions out of proportion to what they should. Such experiences, especially if they occur early, can make us act irrationally. Recognizing these events for what they are, whether they take place out on the open seas, or in our stormy investment world, might bring a lifetime of benefit.

For instance, as a result of my childhood nauseating, nautical misadventures on that party boat, I still don't care for mayonnaise, or mayonnaise-based dressings. I can handle mustard, ketchup, relish, or basically any other condiment you might want to throw at me -- just hold the mayo.

I've also never played a single game of backgammon since losing that fateful match decades ago. I swore off any such diversion where luck could play such an overriding role in the outcome.

And for a few years, I secretly cringed whenever I administered a clot-busting medication for heart attack patients.

But, gradually I'm learning to overcome the power of one. I now realize that, although luck might play a role in backgammon, it's a game where skill usually dictates the outcome. After refusing for years to play with my kids, I think I'll give the game another chance. (Backgammon might even shed some light on our investments, as a recent Fribble claims.)

After treating literally thousands of cardiac patients, I'm now convinced that the benefits of clot-busting drugs easily outweigh the risks. Such medications have been shown time and again to decrease the mortality rates from heart attacks by about 25%, despite the rare tragic adverse event. In fact, a few years back, I wrote an article that extolled the benefits of both these drugs and Foolish investing -- no easy feat!

The power of one can play a role in our investment behavior. For instance, for many seniors growing up in the 1920s or 1930s, the wrenching economic effects of the market crash of 1929 are indelibly etched into their psyches. In order to avoid future catastrophes, many invested their nest eggs in the financial equivalent of their mattresses -- in ultra-safe treasury bills or insured certificates of deposit. They've missed out on decades of financial growth.

Similar to my early backgammon experiences, I've known people who started investing in stocks, but lost money initially, often through no fault of their own. They just happened to start investing at a time when the market took a downturn. Or perhaps one of their stocks fared poorly. But because of their early, money-losing experiences, they sold their stocks prematurely, and swore off investing in equities altogether.

Relatively new Fools might succumb to the negative effects of the power of one. I've talked to a number of investors who have started out in the last year or so investing in either the Foolish Four or Beating the S&P (BSP), with results that haven't lived up to expectations. Subsequently, some have given up on the concept of value investing altogether, and have put 100% of their investments in high-flying growth stocks. But dumping all your Foolish Four stocks because of one (or even more) mediocre years might be the equivalent of withholding lifesaving medication for heart patients because of an early, unlucky, adverse event.

Why do certain early experiences disproportionately affect our subsequent actions, often making future behaviors irrational? I'd say it's because these events occur in observational vacuums, before we've had much of a chance to acquire and assimilate very much data. Scientists recognize that discovering truths requires many observations in order to achieve statistical significance. One particular adverse event, even one that's relatively rare, could occur early on in our set of observations, or much later -- if at all. If such an adverse event, even a rare one, occurs early enough on in our data-collecting life, the emotional experience created might overwhelm our capabilities to deal with it rationally.

Our early life experiences need not be negative, but could be disproportionately positive as well. The danger here is that, instead of leading to risk-avoidance behaviors (as is the case of for depression-engraved memories), the occasional dramatic lucky success might encourage investors to take irrational chances. A recent post-of-the-day, "The Real, Real Risk of Margin," by Globalstreamer, tells the of the perils of investing on margin. This dramatic tale, courageously told by a young investor, may well save investors everywhere thousands if not millions of dollars.

Recognizing that early life events might have a disproportionate effect on our emotions and subsequent actions is the key to harnessing the power of one. This requires constant testing, observing, questioning, and fact-finding. And patience. In the end we'll be rewarded. Maybe even with a decadent eight ounce grilled sirloin burger -- just hold the mayo, please.

Beating the S&P year-to-date returns

(as of 05-02-00):

Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %>           -1.4%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %>            +6.8%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>       +1.8%
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %>    -0.1%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %>         -8.1%
Beating the S&P                -0.2%
Standard & Poor's 500 Index    -1.6%

Compound Annual Growth Rate from 1-2-87:
Beating the S&P               +23.7%
S&P 500                       +17.4%

$10,000 invested on 1-2-87 now equals:
Beating the S&P             $167,500
S&P 500                      $84,100