Investing Advice for Oldsters ... Buy Low and Sell High

Will Rogers said that the key to successful investing is to buy low and sell high. No kidding.

Knowing when to do so is the missing piece of the buy low-sell high puzzle. That said, it's not all that difficult to do and oldsters need to look at it carefully these days.

How you can be a smart market timer is subtitled 'To get top dollar, buy, reinvest, rebalance and hold:'

"Investors complain a lot about the performance of their mutual funds, but they’d be a lot happier and do better financially if they simply got the same results as those funds earn.

Instead, a new study from investment researcher Morningstar Inc. shows that investors habitually get the worst from their funds, earning lower returns than the investment vehicles they are buying.

You don’t have to settle for that.

To see why, consider the latest research from Russel Kinnel, Morningstar’s director of fund research, who compared a straight average of fund returns to an asset- or dollar-weighted average investor return.

Dollar-weighted returns are designed to show a fund’s results based on when money moves in or out; they show if investors are chasing performance, buying funds only after a big runup or losing faith and selling before a rebound.

Kinnel found that over the decade ended in 2012, the average stock fund returned 7.05% annually, but the average investor netted 6.1%. . . .

Time and money

Giving into fear or greed is the root cause here, but investors may not recognize that their behavior contributes to the shortfall.

“Mutual funds are long-term investments and the way to get a superior return is to hold it for a long time,” said Kinnel. “It used to be that people made decisions based on the fund’s returns over the last few years. Now it seems to be that they make decisions based on the 24-hour news cycle and what they just heard. Either way, they’re making bad decisions.”

Here’s how that plays out.

The typical investor buys funds only after a strong run of good results, thus they are buying high. Their money did not get that positive performance stretch, however; they only get what happens next. If the fund slows or falters, the fund’s performance may still be positive but the investor hasn’t really experienced those gains.

If the investor sells when the fund falters, they not only lock in a loss or poor results, but they also go a bit insane, repeating the process again — buying another fund that has been hot — but expecting different results.

Here’s how to get the performance close to what the fund provides: You must reinvest dividends and distributions and make additional deposits either regularly or when the fund seems undervalued, rather than when it has made the account statement look fat.

“Macro timing is bad for people because they fool themselves into thinking they can outsmart the market,” Kinnel said. “They hear some news or see some hot numbers and they don’t realize that in jumping on this bandwagon, what they are saying is ‘There’s a lot more good news coming, even though I don’t know anything more than anyone else about this.’”

It’s important to recognize that lackluster dollar-weighted returns are caused by the individual investor, not the fund, and that they happen to people who own good funds.

“The one way you can wreck a diversified portfolio of solid, low-cost mutual funds is by doing a lot of market calls,” Kinnel said. . . .

Balance and rebalance

Avoiding the problem involves striking an appropriate balance between fear and greed — and not acting on either.

In fact, the best way to ensure performance that is close to what the fund delivers is to rebalance a portfolio. . . .

Experts about investor behavior note that investors don’t need to ignore human nature, but rather have to understand it."

Summing Up

Knowing a little about our all too human nature is the key to investing.

We experience much more pain when stock prices fall than we experience pleasure when the market rises. That's just the way we're wired.

Accordingly, knowing ourselves and our tendencies is essential if we want to become successful long term investors, and we should all want that.

To state the obvious, a little means a lot in investing. Each 1%, up or down, will add up to a whole lot over a lifetime of saving and investing.

Just the difference of earning 2% less on average annually, whether from paying commissions, trading costs, or being out of the market at the wrong time, will cause the individual individual at retirement to have 50% of what he would have had had he earned that 2% on average. That's the rule of 72 at work again.

That said, when we approach oldster status, it's a good idea to take some gains off the table and not subject ourselves to the need to sell when prices are low.

It's all about knowing yourself and your financial needs. For those who have enough income, whether from dividends, earnings, Social Security or otherwise, staying the course through thick and thin is not a bad idea.

For all other oldsters and near oldsters, however, it's best to have some cash on hand in order not to have to sell when market surprises hit, which they do with uncanny but predictably unpredictable regularity.

That's my take.

Thanks. Bob.