Are We Buying High All Over Again?By CARL RICHARDS
Carl RichardsCarl Richards is a certified financial planner in Park City, Utah. His sketches are archived here on the Bucks blog and on his personal Web site, BehaviorGap.com.
We’re doing it again: Buying stocks after big gains in the markets.
In 2008, 2009 and most of 2010, mutual fund investors in almost every month took more money out of stock mutual funds than they added. Then, in January, someone hit a switch.
Investors decided that it was time to get back into the stock market. Keep in mind this decision came after an almost 100 percent gain from the market bottom in 2008. So in December we pulled $10.6 billion out of equity mutual funds, and in January we poured an estimated $30 billion into the market.
Do you see the problem here?
Unfortunately, investors are repeating past bad behavior. We broke records with market inflows in December 1999 and for the first three months of 2000, right after an enormous run-up in technology stocks and right before a nasty decline. We have an uncanny ability to buy high and sell low, the opposite of what we are supposed to be doing.
If you’re still not convinced, let’s take a look at the S&P 500. On Feb. 16, 2011, the S&P 500 hit 1,334. That number matters because it represents a doubling of value from the previous market low of 666.79 on March, 6, 2009. Great news, right? Do the math:
…the S&P took less than 23 months to rise 100 percent, which appears to be its fastest double since S&P started publishing the index in 1957.So does it really make sense to chase the market at this point?
The tricky thing is that we don’t know how the market will do over the next six months, the rest of the year and beyond. Maybe the $30 billion that poured into equity mutual funds in January is just part of a rational asset allocation decision, but our past bad behavior points to something else.
Unfortunately, we’re hardwired to want to move away from things that cause us pain and move closer to things that give us pleasure or a sense of security. From that perspective, wanting to sell when everyone around us is panicked and fearful and buy when everyone starts feeling better and things have cleared up makes perfect sense.
But what does cleared up mean? Does it mean people are less fearful? Does it mean the news reports are positive? Does it mean our friends are investing again?
Keeping all of these signs in mind, do you you think the market will move higher or lower when things clear up? Higher, of course. So this decision to wait until things clear up sounds like a plan to sell low and buy high on purpose. It’s a bad idea and an avoidable mistake.
Another reason we may jump back into the market is that we can’t take the pain of watching it rise day after day. Maybe in early 2009, you decided that you were done with the stock market forever. Then as the days went by and sustained positive returns emerged, you started feeling like you were missing out. Your friends were talking about investing it again. It was killing you. “O.K.,” you said to yourself, “maybe it’s about time to get back in.”
So how do we stop the madness and avoid the same mistakes again next time the market goes down? (And it will go down again, I promise.)
1) Have a plan. I am not talking about one of those worthless, two-inch-thick books. I’m talking about the process of sitting down and deciding where you are today, where you want to be in the future and how you plan to get there.
2) Decide if that plan means that you need to invest in stocks in the first place. It might not. Your plan could involve saving more, adjusting your goals or retiring later. The rate of return you need to achieve your goals is just one variable to consider.
3) Find investments to populate the plan. This comes at the end of the process and is certainly not the first part. After all, you would never spend time deciding what car to drive on a trip until after you decided where you were going.
4) Make changes only if the plan changes. Your plan, and not what the market is doing, should drive your behavior.
We don’t know what comes next for the market, so we need to focus instead on the process of getting from where we are today to where we want to go. It’s the only part of the process that may give us some control.
Link: http://theweek.com/article/index/212397/sell-low-buy-high-are-investors-being-stupid-againUseful Comments:
- The stock market is a casino with the rules in favor of the big boys who can execute trades in a millisecond. Unless an ordinary investor has a big ego about their decision-making powers, they should stay away from it.
- I think the most salient bit of advice you give is the one regarding the "two-inch thick" plans--which are always just a series of restatements of the data you gave the "planner." The best questions come from someone not afraid to challenge you...with something other than incomprehensible numbers: Why do you want to retire to Florida? Why do you want to pay all your kid's education loans? You may have to work another two years, you know, to get what you want. Buying a new car at that price is crazy, isn't it? You are right on that point, in spades.
As far as stock prices go, though, I think that you are overly pessemistic. They are clearly going to be impacted, and heavily, by the Mid-East troubles and the fears of oil shortages and their impacts in India and China. You could easily see DOW 11,000 by mid-March. Maybe 10,500. But most of that, like S&P 667, will be over-reaction. The S&P was grossly undervalued at 667--and probably is overvalued at 1250 just as the DOW is at 12,500. But neither is now as overvalued as it was then undervalued. You see a huge run up in that S&P from 667. I see an inevitable correction to 950 (where smart people made money) and then some "exuberance" on top of that.
Given the Mid-East, I'll sit and wait a bit. Gas at $4? I'll drive less.