When discussing traits of a prudent investor, we must first consider the types of investor behaviors that can negatively impact a sound financial plan. In my experience, investors tend to make poor decisions when emotions get involved in the process. These poor decisions can have not only short term implications, but ones that can last long into retirement. A study by Dalbar Inc. over a 20 year period from 2001-2020 shows that the S&P 500 stock index returned an average of 7.5%. However, the average investor only returned 2.9%. This is a significant disparity, and one that deserves some attention as to why this is happening. Understanding investor behavior can go a long way in avoiding common mistakes the average investor makes.
Day trading is the attempt to trade the market, buying or selling, based on very short term trends, intraday or interday. Some believe they can beat the market by actively trading based on deploying different strategies and the current day’s headlines. Few can do this successfully on a consistent basis. At a certain point, those who were seemingly doing well, will make a series of wrong decisions and they will realize no better, or worse rates of return than if they were less active. Day trading can be a fun hobby if trading stocks interests you. If you have this desire, then I say go for it- but only if you are on track for retirement, and only if it’s a very small part of your assets- an amount that you are comfortable with potentially losing all of it.
Market timing can be one of the most harmful investor behaviors that can impact your financial plan for decades. Market timing is making decisions to buy or sell based on predictions of the future. In this definition, the future could be as short as the coming days, months, and years. The decisions made in market timing are almost always based on emotions, and rarely based on any kind of long-term, planned strategy. Fear can make investors sell out of stocks when things are bad and markets are down. I’ve seen this many times over the years. The question that needs to be asked when there’s an urge to get out is, “What’s the plan to get back into the market?” Investors never have an answer for this. What happens is that they wait until things look good again in the markets, which means they’ll wait until things go back up. So ultimately, investors will sell low, and then buy high. This destroys the most basic rule of investing which is to buy low and sell high. Our most recent example is from the early days of the COVID-19 pandemic that tanked the stock market in February/March 2020. On February 12, 2020, the Dow Jones Industrial Average (the Dow) closed at what was then an all-time high of 29,551.42. The economy was strong and unemployment was at historic lows. Within 5 ½ weeks, on March 23, 2020 the Dow closed at 18,591.93, down 37%. COVID-19 had come to the United States. Fear of mass sickness and deaths resulted in lockdowns, closed businesses, and rampantly high unemployment. There was panic and investors wanted out of anything that involved risk. The big investors (usually the large financial institutions and professional money managers) saw a market situation with current great buying opportunities and at that time what they thought would be a future with a virus that would eventually get under control. Stunningly, the Dow made a full recovery just months later and reached 30,000 for the first time ever in November 2020, even as the pandemic continued. For those who were selling their stocks on March 23rd, at the low point of the Dow, you have to wonder when, or if, they bought back in, and how much higher the market was when they did.
From an advisor perspective, it’s my job to remove emotions as much as possible and focus rather on an investor’s financial plan, their long term goals, and their time horizon. As hard as it can be, individual investors must be aware of their emotions and how they can negatively impact their retirement savings.
On the opposite side of this spectrum is the feeling of exuberance and confidence as markets hit all-time highs. At this stage, investors tend to believe that nothing can go wrong and that it’s safe to dive back in or invest the cash they’ve been saving. This is actually the time I am encouraging clients to harvest some of the market’s gains by rebalancing. If a client has more in stocks than they are comfortable with (based on their risk tolerance) due to growth, then it’s common to sell some off and buy something more conservative, or less correlated to stocks.
Poor market timing due to emotions can be managed by properly understanding your risk tolerance, risk capacity, and time horizon. We will continue traits of prudent investing with these concepts next time.
Tell me about your personal experiences, good or bad! I’d love to hear from you: Christopher.Hull@CeteraInvestors.com or 716-707-1818.
Investments in securities do not offer a fix rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and, when sold or redeemed, you may receive more or less than originally invested. No system or financial planning strategy can guarantee future results.
The views stated in this letter are not necessarily the opinion of Cetera Investors and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.