Two Emotions Kill Your Investment Returns
In 2014, resolve not to “time the market”.
“Time in the Market” is one key to long-term investment success.
When you look at the chart below you will see just how bad retail (non-professional) investor’s performance is compared to what they could have made had they only been “buy and hold” investors.
THE NUMBERS ARE SPECTACULARLY BAD FOR INVESTORS.
Why do smart people do so poorly as investors? Logic tells us ideally that if we “buy low and sell high” we will do well.
Unfortunately, human emotions get in the way of logic and are the main contributor to the horrible results do-it-yourself investors achieve over time.
1. GREED– If I asked most people if they considered themselves to be greedy, they would say “no”. Investment greed is prevalent, but obviously not easy to recognize. If you see a stock that has been going up for a while and that excites you enough to get you to want to buy in, you are choosing to buy in an inflated price in hopes of cashing in on even higher prices in the future. I call this a form of “greed”. It happens everyday. Mutual fund companies track their retail inflows and when their funds have positive performance, the money starts coming in at a faster pace. When the past performance is really good, new money comes in at an even faster pace. All this money is buying in at higher and higher prices (not exactly buying low).
At some point, a market peak is reached (there is no one ringing the bell when this happens), but not until after the prices fall will these “johnny come lately” investors sell and move on to the next “band wagon” investment vehicle.
2. FEAR – Fear is a much more powerful motivator than greed. When prices start falling, panic often follows and the sell orders begin. It does not take much in the way of suggestion that prices will continue to fall for people to bail on their investments. At times, the selling begets more selling driving prices to bargain basement levels. The fear of prices going even lower keeps most people from actually “buying low”.
Once you have sold a falling price investment you may be stuck on the sidelines indefinitely. If, after you sell, the price goes lower, you are likely to think that trend will continue making it hard psychologically to buy back in (at low price).
If the price goes up after you sold, it’s hard to buy back into an investment you sold at a new higher price. Just ask people who sold out as the market was going down in 2009.
In summary: Greed leads investors to “buy high” and fear causes people to “sell low”.
This is why active investors have such horrible results time after time with their investments.
The secret to success is to have a real investment strategy. Ideally, your money would be invested so that it was aligned with your specific investment goals and time horizons. Day-to-day market moves would not be on your radar anymore than what happens to the value of your home on any given day.
Investments made without a plan are usually doomed to fail. It shouldn’t matter if there are bumps along the way if you know you are on track to achieve your goals.
You can take your own investment pulse by looking back at how/if you reacted to market swings and bought or sold because of them.
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