Wednesday, April 15, 2009

The Biggest Mistake

The biggest mistake most individual investors make is buying high and selling low. I know that this sounds dumb, but I'm surprised how common it is. I have a few coworkers who have proudly announced that they have recently reshuffled their retirement portfolios into GICs (guaranteed investment certificates). Indeed, one of the most vocal proponents of this strategy told me this about 2 months ago, when the market was within spitting distance of its (local?) bottom.

Now, if you believe the market is going to go lower before it goes higher, then cashing out what you've got and sitting until things improve is a decent strategy. But these are people have sworn off the markets permanently. They say they are not going to get back into volatile investments. So they've taken the full loss that the market handed them, and are going to make it back at interest rates that are currently about 2% annually, and might optimistically rise to 6% when the economy improves.

Worse...I don't believe they're out permanently. If they're driven by their emotions in this down market, it seems likely to me that when they look at all the money other investors are making in the next bull market, they will be tempted to get back in...probably again near the peak of the market. And so this kind of emotionally driven investing will continue to compound their losses with each cycle.

I think this is the reason for the popularity of the Buy-and-Hold strategy. It allows people to hold over the long term and so, while they won't see the big gains of people who sell during bull markets and buy during bears, they will at least see the overall long-term up trend in markets. It works if you don't chicken out, just as the contrarian approach works if you have the willpower to buck popular sentiment.

I don't know that I have any advice, other than if you don't like the market's ups and downs, you should get out during the next bull market, not now. For me, I'll continue with my current strategy of keeping my speculative holdings until I'm convinced they're not going anywhere, and keeping my retirement savings in fairly volatile, equity heavy mutual funds...they've actually only lost 25% in the bear market, and stand to gain much more when the bull returns.

Photo by Timothy Valentine, used under the terms of Creative Common By-NC-SA 2.0.

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