"Going to the sidelines"

Most investors have a recurring fantasy they can dodge market volatility. 

When markets start to tank or look scary, such folks want to “go to the sidelines,” which means parking their money in cash or safe bonds, “until the skies clear.”

When you ask them how they know when to go to the sidelines and when to come back, they frequently tell you they just FEEL it.

To that, I have one thing to say–BALONEY!

Feelings tell you nothing about markets, all they tell you is your emotional state.  Those who use their feelings to guide their investment decisions get nowhere.

Many of these people went to cash in the fall of 2008 or the spring of 2009.  In cash, they have earned maybe 2% returns if they were lucky.  If they had invested whole-heatedly at those times, they’d be sitting on 50% gains or more.  Those feelings don’t look too smart in hindsight.

Market prices tank when people get scared.  That’s when the bargains appear–when people aren’t selling for economic reasons but because of their emotional state. 

The same thing can be said on the upside.  If people feel euphoric–like in early 2000 or late 2007–then it might be time to get more conservative.

Your emotions tell you just the opposite of what to do, so don’t listen to them.

My best investments were made when I was scared.  I normally feel sick to my stomach when I purchase investments with the best upside.  My emotions are terrible guides, and so are yours.

When markets get scary or euphoric, it’s time to look at the data.  What kind of returns will I get given current prices and normalized earnings.  When I get nervous, I look at the data.  When I’m feeling optimistic, I look at the data.  I always look at the data, not my emotions.

For those who think they can go to the sidelines until the skies clear, I wish you the best of luck–you’ll need it! 

If you want to make a bundle on your investments, invest aggressively when you feel scared and get conservative when you’re euphoric.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

"Going to the sidelines"

Don’t invest with your heart, invest with your head

Emotions make us lousy investors. People, as humans, tend to act in emotional ways during tough or exciting times. When people give in to emotions–investing with their hearts instead of their heads–they get lousy results.

If you’ve refused to sell a losing investment, bought because everyone else was, sold because a stock’s price went down, picked investments because they seemed safe, or sold because the economy looked dreadful, then you’ve invested with your emotions. Don’t feel bad, everyone fights and succumbs to this at some point.

The field of behavioral finance has clearly shown that we humans suffer from several biases that lead us to make unwise investment decisions.

For example, there’s anchoring bias. If you hold an investment waiting for it to get back to the price you paid, you’re suffering from anchoring bias. If you wait to buy an investment until it declines back to the price you could have bought it at (and regret not having done so), that’s anchoring bias again.

Another bias is called recency bias. This is the tendency to think that recent events are more likely than they are (and that distant events are less likely). Someone who buys hurricane insurance because a bunch of hurricanes seem to have hit recently is suffering from recency bias. Someone who drops earthquake coverage because an earthquake hasn’t happened in a while has been hit with recency bias.

Loss aversion is one of the most common biases. It happens when people refuse to sell an investment because they don’t want to “book the loss.” People feel losses more keenly than gains, and they usually need twice the gain to make up for a given loss. This can lead people to make bad investment decisions by holding on to something they should sell.

Then, there’s the endowment or halo effect. This happens when one particular good attribute overwhelms all other attributes. Many people still see GM as a great company because it was in the past, even though there’s a lot of evidence it isn’t anymore. It can also happen the other way around, when one particular bad attribute overwhelms all good attributes. Many assume a company whose stock has gone down a lot must be bad, even though it may have many excellent characteristics. The price drop seems to overwhelm everything else.

Finally, there’s overconfidence. When asked, we all claim to be above average drivers, kissers, and investors, but this isn’t Lake Wobegon and everyone can’t be above average. It’s hard for us view ourselves objectively, and so we make unwise investments when we feel more confident than the facts suggest.

The way to fight these biases is simple, but not easy: discipline. If you use strict criteria to buy and sell investments and act on that criteria, you can fight these emotional biases and win. This will greatly improve your results. Even better, If you’d prefer to let someone else be disciplined for you (I’m not unbiased on this suggestion), then unemotionally select an advisor that can act with discipline on your behalf.

Invest with your head instead of your heart, and you’ll get dramatically better investment results over the long term.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.