Buy low and sell high, that is the money-making motto we’re all familiar with, yet most people tend to do just the opposite and buy high and sell low. The problem is that most people don’t even realize they are doing it and they think that the changes they are making to their investments are actually helping.
This Week is a Perfect Example
If you have paid any attention to the news in recent days you are probably aware of the fact that the market has seen its worst week in five years by dropping 4-5% during that time. While that is a relatively significant drop for such a short amount of time it is really a blip on the radar over the longer term trend of the past few years, but that isn’t what most investors see.
Today, the first business day after last week’s painful drop has kept me busy trying to field calls and address people’s concerns over their accounts but the problems don’t stop there. Many people are making drastic changes to their investment holdings that can have a lasting impact on their total returns. These people are selling off their equity holdings and moving to a very conservative allocation. All this does is lock in a guaranteed loss of anywhere from 3-6% on average depending on actual holdings.
Too Little Too Late
If you’re making changes to your holdings after the market has moved, you’ve missed the party. People hear the news of how bad the market is doing so they think by getting out and moving to something safe that they are protecting their portfolio from even worse losses. While in theory this could be true if the market continued to dive for an extended period of time that usually isn’t the case. What generally happens is the market stabilizes a bit and may even give back some gains after the correction, but those who moved into cash or bonds are now missing the boat. They already sealed the losses by selling so they have to rely on interest or dividends to recover the gains.
What’s worse is that people who tend to make drastic adjustments due to a market loss will make the same mistake when the reverse happens. When these investors get shaken and move to a very conservative position it will take them a while before getting back into the market. I’ve seen this happen all too much when people who got out of the market completely around 5-6 years ago and they come to me upset that their money market or fixed fund isn’t doing as well as their co-workers who are in the market. So here it is many years later, they have been earning 3-5% per year and have missed out on some significant gains with the market setting new record highs and people are flooding in and buying at what could be the top.
The Importance of Staying the Course
If your investment goals are geared toward long-term appreciation you have to realize the importance of being confident and comfortable with your allocation and to fight the urge to make drastic changes in reaction to market activity. Again, if you are making changes after a large event has already taken place, you are too late. If you continue to do this you will enter a vicious cycle where you are always buying high and selling low by trying to time the market.
This doesn’t mean you shouldn’t make any changes at all, because there are times you may want to make some minor adjustments. But what you don’t want to do is if you have a 90/10 mix of stocks/bonds that you don’t rush out and move to 100% bonds on news that the market has a bad week. If you have a reasonable asset allocation and stick to it then over time it will perform pretty much as expected.
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.
You make some good comments here, cemented by your posts on dollar cost averaging. Keeping a cool head is hard when you see your investments swinging. If you trade, like us, thats great, but keeping your head and thinking long term is the key for retirement portfolios.
You nailed it. I recently wrote an article myself about the topic. If Target, Best Buy or Macy's announced a major sale, people would be lining up at the door. For some reason, when stocks go on sale people run the other way... I think that's strange.
I think that its a pity that so many people buy high and sell low without realising. I've got a boring automatic regular investment into index funds myself.
I was lucky and my last 401k contribution came in and got friday's closing prices. Good discount!
But in the end it really doesn't matter, the market goes up and it goes down, it just happened to go down more than usual in such a short period of time. If you stay the course and keep contributing it will turn out fine in the end.
I'm just hoping that my pending 401k contribution gets sent in before it rebounds. It's like all my funds are on sale :)
I'm hoping the market stays down until the first of the month when my automatic purchases are made, then it can go back up :)
Great article. I don't even worry about the stock market on a short-term basis, because all of my investments in the stock market, and my client's invesmtents, are for 10-50 years out. Frankly, I don't pay attention, except just enough to answer client and press questions.
What happens over one week is not relevant -- except for the fact that other people selling high is great for us, because when we buy our monthly investments, we get to buy at an even lower price. :)
Excellent article. I also wrote something similar, more illustrative, but less thorough than yours. Just hang on tight folks.
Hey Jeremy, its great that you're addressing this. I just wrote about it too. I've had some friends, who are pretty risk adverse call me up and tell me how much their portfolio went down and how all their hard work saving "went down the drain". I told them not to worry and stay on course. Some times its tough to see these ups and downs on paper and when its your own money, but thats just the way the cookie crumbles. Great article as always Jeremy.