I’ve talked about this trend in the past where people do just the opposite of what they should be doing. Ask even the most novice investor and I bet they can recite the words “buy low and sell high” to you. It’s an incredibly simple concept, yet most people can’t follow through with it. Human behavior plays an important role in determining actual investment returns. All of those numbers you see about gains, losses, and what the Dow is doing? They are important, but not as important as the decisions you make.
This morning I was catching up in my feed reader and I stumbled across a post over at Behavior Gap titled When Things Clear Up. If you haven’t been over to The Behavior Gap before, I suggest you check it out. Carl does an amazing job in pointing out the deficiencies in human behavior that lead the average investor to realize even worse returns than what their actual investments they hold return.
In Carl’s post about when things clear up I see a striking resemblance to the discussions I’ve been having more frequently in recent weeks. He points to an NPR story where a couple confesses to getting out of the market back in March, but are now ready to get back in because they think things have cleared up.
Everyone Becomes a Pro During a Rally
That’s right, this couple and everyone like them who waited 18 months for the market to cut their portfolio in half before bailing out has suddenly achieved great wisdom and is ready to invest again a few short weeks later because the market had a decent rally. I’m seeing this play out on a daily basis just like Carl pointed out. How can someone who couldn’t predict these massive losses suddenly predict the very bottom of the market and know it’s time to get back in?
People sell due to fear, but that fear only comes after you’ve lost money. You don’t have this fear when things are doing well. So by the time you feel bad about your losses, they have already brought your portfolio down and you’re probably going to sell at a loss. Then, people want to get back in when the fear is gone, but guess what? We lose this fear only after the market begins to rebound. And you know what? That means you’re selling low and buying high — just the opposite of what you know you’re supposed to do.
Don’t Let Your Behavior Undermine Your Returns
I’m no pro when it comes to predicting the stock market. In fact, most people aren’t. If you want to maximize your investment returns, you need to exhibit the right behaviors. If you let the headlines and your quarterly statements drive your investment decisions, you’re probably going to be one step behind and reacting to an event. If you react, it’s too late. Instead of reacting, you want to be planning.
With planning, you are putting measures in place to take advantage of the future. Yes, the future is unknown, but you can still create a plan that will maximize your returns based on your investment objectives. Then instead of always taking action after something happens, you can keep your emotions out of it and know that you’re doing what’s best based on sound principles, not a reaction to an event in the past.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
Psychologically I actually find it easier to buy into a downturn than into a rally....I have been consistently buying into this downturn (each month on a regular basis), but this month when it was time to invest more I found myself reluctant to do so - after 6 weeks of a rally, I reasoned, we were just about due for a downwards correction.
Great post. I think that the money quote is:
"All of those numbers you see about gains, losses, and what the Dow is doing? They are important, but not as important as the decisions you make."
In fact I liked that so much I have already twitted it. It really is amazing. IF you decide that you need to be in stocks for your long-term plan to work, then think through what Jeremy has posted. Selling to sit in cash until "things clear up" is an actual plan to sell low and buy high. That is a bad idea.
Excellent explanations of the faulty psychology that goes along with most investors! Almost funny if it didn't have to do with real people and their real losses in the market. Whenever I think about "buy low sell high" now I'm always reminded of my being able to buy some TD Bank stock at its lowest 52-week mark, when it seemed *unbearably* *unseasonably* low, but since I had been studying its reactions to the downturn, I knew (or assumed) that it would just go right back up again because the market wouldn't let it stay at that level. And it did. It's back up over 32% in a month.
That said, I don't plan on selling any of my stocks, so I guess the "sell high" doesn't apply. But I like the idea of "making your money when you purchase" - and that means buying low.