Mistake at work

 

You review your investments and notice that one is not doing well. You sell and buy a different investment that has been doing well for a few years. You heard favourable news in the media, internet or from your advisor related to the new investment.

That’s it! That is the gigantic mistake you keep making. That is the reason your long term investment returns are low.

In case you missed it, what you just did was sell low and buy high.

You know, of course, that smart investing means you buy low and sell high. Then why do you keep doing the opposite?

Most investors do this bad market timing every time they review their investments. The effect is gigantic.

The annual Dalbar study has consistently shown that the average investor makes between 3% and 7% per year less than the investments they own. If you just buy and hold, you make the return of the investments you own. But investors make 3-7%/year less because they continually buy high and sell low.

I know what you’re thinking. If an investment has been “doing well” for several years, doesn’t that mean it’s a good investment? Sometimes. But most of the time, it means it is a popular investment that is expensive. You pay more because it is popular today, but at some point in the future it won’t be.

In my 20+ years in the industry, I have seen that at any point in time there is an “investment du jour”. It fits the mood of investors and is heavily marketed by the industry to both advisors and DIY investors. For example:

TimeInvestment Du Jour
Early 1990sEmerging markets
Late 1990sTech stocks
Early 2000sBonds (after the bear market)
Mid 2000sIncome trusts, banks & resource stocks
Late 2000sBonds & cash (after the crash)
Early 2010sGold, “anything with a yield” (bonds/dividend stocks), and conservative/“low volatility” stocks.

 

Most investors bought the “investment du jour” after they had been “doing well” for a few years (near the high). Then sold after they lost money or lagged in order to buy the next one.

Buy high and sell low. Over and over again. Gigantic mistake!

What is the “Investment Du Jour” today? The general mood of investors is still cautious, remembering the crash of 2008. Investors are focused on lower risk and yield. They have been piling into slow growing companies that are now expensive. Low growth companies are marketed today as dividend, conservative or “low volatility” stocks. For the last few years, low growth companies have generally had better returns than faster growing companies. Clearly, this is not sustainable.

In short, today investors are searching for dividends and lower risk investments, but end up preferring expensive low growth to cheaper high growth. They are looking at recent past performance and ignoring that expensive, low growth companies cannot be expected to keep up with the broader market for the next 5-10 years.

It is always best to avoid the popular investment types. The best opportunities are always somewhere else.

If you have an advisor, are you protected from this bad market timing? The evidence is that financial advisors are as bad or worse than the general public at this bad market timing. They have so much exposure to investments that they tend to buy high and sell low more often.

Bad market timing feels natural. The human gut was not designed for investing. Your gut instinct may serve you well in many areas of life, but not in investing. If your gut is human, you cannot trust it with investing.

Your advisor shows you that the last 3-5 years, or even 7-10 years, look good. This can result from only a couple recent good years. Your human brain tends to believe trends continue. Investments go through cycles, though. Today’s popular investment won’t be popular for long.

This gigantic mistake is so easy to make, that you need a definite process or discipline to avoid it.

How do you avoid this gigantic bad market timing mistake?

You need an effective investing discipline:

  1. Never buy an investment because it is “doing well”. Remember: “Doing well” = expensive. At every review, ask yourself: Do you want to:
    • Buy low & sell high?
    • Buy high & sell low?
  2. Avoid anything that is popular or being sold to you. Be aware of the general investment mood. Notice what is being heavily promoted in the media, blogs and advertising – and probably by your advisor. Then avoid it.
  3. Ask your advisor what his discipline is to avoid bad market timing.
  4. Buy quality investments that you can hold for the long term. Warren Buffett says that if the stock market was closed for 10 years, it would not concern him. He is comfortable with all his investments long term. For example, if you invest with:
    • Your own stocks – Buy quality companies
    • Mutual funds or seg funds – Buy All Star Fund Managers
    • Buy ETFs – Stick with very broad markets, like MSCI World.
  5. Rebalance only occasionally – once every year or 2. Rebalancing once every 2 years has been shown to outperform more frequent rebalancing.
  6. Add your new contributions each year to your worst investment. Buy low.
  7. Rebalance by adding money to your worst investment. Buy low.

Bad market timing is buying popular investments that are “doing well”. This is a gigantic mistake.

Discipline to avoid it will probably improve your long term investment returns more than anything else.

 

Ed

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