Wednesday, January 15, 2014

Buy Low and Sell High is the Basic Idea Behind Long Term Investing Success ... Why Then Do So Many Do the Exact Opposite?

Too many people confuse short term stock market price volatility with long term market direction. For the short term oriented traders among us, good luck with the game you're playing. I hope you win. But for us long term investors, let's get our market set of buy and sell behaviors right. If we do, I know we'll win.

Only two prices are relevant when determining whether we are making or losing money on our stock investments: the price we paid when buying and the price we receive when selling. All the short term gyrations and ups and downs of the market are just noise. And often harmful noise at that.

So why do we often behave in a self-defeating way? Human nature --- that's why. We have more of an aversion to 'losing' money (even if it's just a short term paper loss) than the satisfaction we experience when our investments increase in value. For example, the Dow gained 116 points yesterday after dropping 179 points Monday. If you're like most people, including me, Monday's loss made you feel bad. On the other hand, yesterday's gain didn't really make you feel so good. Part of it is expectations. We expect that our investments will go up. We don't expect them to go down. And when they go down, we're impacted emotionally in a negative way.

That's simply the way we're wired. But that self-knowledge can help us avoid making self-defeating moves at times of market volatility. In other words, we are who we are and we feel how we feel, but we don't need to act against our own best interests. To be forewarned is to be forearmed.

So for many longer term term investors, the best behavior is to put money into a low cost S&P 500 Index fund regularly and then ignore the market's ups and downs. Check it every year or so, but don't get 'hooked' and become an unintentional trader.

Why We Buy in a Marked-Up Market is helpful in learning to do the right thing for ourselves. It's all about our all too human tendency to buy high and sell low which, of course, is a losing way to invest. Here's what it says:

At the same time, however, the numbers also show that we have lost our appetite for stocks.

According to the research firm Lipper, from 2006 to 2012 we withdrew more than $450 billion from United States stock funds. Then, in 2013, someone flipped a switch, and we decided we liked stocks again. Through the middle of December 2013, $60 billion was added to United States stock funds.

Think about this switch for a second. When the entire stock market had a huge 50 percent-off sale in 2009, no one wanted to buy. Now that the market is marked up 200 percent, we feel that it is time to get aggressive again.

A technology sales manager was recently quoted in a recent article in The Wall Street Journal: “Frankly, from 2009 until recently, I wanted to stay very conservative,” he said. Now, “I want to get more aggressive.”

Now? More aggressive? Why weren’t people more aggressive when stocks were on sale? . . . .

Ultimately, it comes down to fear. People are worried about missing any more of the market’s gains. As a result, for example, they change their 401(k) allocations to be more aggressive (that is, invest in more stocks).

Do we behave like this with anything else?

Imagine walking into a car dealership, and the sales representative greets you with: “It’s your lucky day! The car you want is now twice as expensive as it was yesterday.” You get excited and say: “Great! I’ll take two of them!”

Stocks and other investments are the only things we rush to buy after they are marked up and hurry to return when they are on sale. We don’t care that we are losing money. Just take it back! We want out!

I know why we do it — we feel as if we have to. It feels like a matter of survival. We’re hard-wired to pursue the things that give us pleasure or security, but get away as fast as possible from things that cause us pain. When the stock market holds a once-in-a-decade sale, it’s scary. The news is scary.

Your neighbors are scared, and then we get scared.

We think the only way to stop the pain is to get out. Then, after swearing we will never invest in the stock market again, we watch it rally for a few years beyond old highs. We start hearing the news.

Our neighbors start bragging about their returns, and before we know it, we are adding stock symbols to our iPhones and buying stocks again.

We have fallen prey to a cycle as old as trading itself. We buy high, sell low, and now we’re positioned to buy high again. . . .

We are doing the very things — buying high/selling low, turning over quickly, reacting to the news — that evidence shows does not help us to be better investors. Why? Investment success is not a matter of more information, intelligence or skill. It’s a matter of behavior.

By recognizing that success is about behavior and not something else, we can start building in the corrective measures that will help us avoid mistakes in the future. We can put emotional guardrails in place to help us avoid behavior that keeps us from reaching our financial goals.

Once we accept that buying high and selling low is our natural tendency, then, and only then, can we start to fix it."

Summing Up

Our seat of the pants emotional self often overrules our objective rational self in decision making.

When it comes to investing in stocks and many other big ticket purchases, we often act like Pogo said, as our enemy.

So if we can't control our emotions and resist the urge to get out of the market when the fit hits the shan from time to time, then we should never get in the market.

That's because while markets do rise over extended periods of time, in the interim they will inevitably fall and sometimes fall hard.

The pros say we're in for perhaps a 5% to 10% fall in prices (aka a correction or fallback) sometime this year along the way to higher prices.

To which I say, "So what? I'm in it for the long run."

That's my rational self overruling my emotional self.

Thanks. Bob.

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