Stupid Investor Tricks

Don't get me wrong. I'm not saying investors are stupid. I'm saying they follow the advice of people who pay no attention to the data. As a consequence, they engage in "stupid investor tricks."

Here are some examples:

1. Relying on pundits--not data--to "explain" the significance of current volatility. Neither is predictive, but at least the data is accurate. Historically, volatility has meant poor returns. But over the past 82 years, periods of negative returns (six months or longer) have been followed by periods of positive returns, on average.

2. Using volatility as an opportunity to pick stocks or time the market. You would think these strategies would work better in times of high volatility, but consider this: Do you really believe you (or your broker) know more about the markets that the collective wisdom of the millions of investors looking at the same data? Remember, if you are buying, they must be selling. One of you is going to be wrong. Do you regard a 50/50 chance as good odds?

3. Overreacting to current market conditions. Over the past three years, ending September 30, 2008, it would be extremely difficult to find any asset class of equities, domestic or international, or any bond index fund, that did not report positive returns. If your time horizon is less than 5 years, you should not have any exposure to the stock market. In times like these, it's important to keep long term returns in mind to give yourself some perspective and avoid panic.

4. Using the S&P 500 as a proxy for "the markets." The ten year returns of the S&P 500 have been dismal--less than 3%. This has lead to many misleading articles about "the lost decade." But the S&P 500 is not a proxy for the global equity markets, which is why investors should have a globally diversified portfolio of low cost index funds for the stock portion of their investments. The annualized return of this portfolio over the same period was in excess of 7.50% (through September 30, 2008).

5. Engaging in active management. According to a recent study by Kenneth R. French, for the twenty-six year period from 1980-2006, if a representative investor switched from an active to a passive market portfolio, he would have increased his average annual return by 0.67%. We are talking serious money here. No great skill is involved, yet over 90% of all individual investors flush this money down the toilet every year.

6. Buying hedge funds.. Professor French found that the typical hedge fund investor did not break even in 2007 unless his U.S. equity-related hedge fund generated an average abnormal return of 6.48%. "Abnormal returns" means the hedge fund had to exceed the market returns by that percentage. That is like running the 100 yard dash with a 50 pound weight on your back.

These troubled times demand that beleaguered investors teach themselves new tricks.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.

Comments

[pup sydney]

How cleptocratic to force employees to buy into a 401 or 403k plan for a pension!. True choice would be to have on one hand a federally GUaRANTEED pension fund at 3 or 4 o5 or variable percent rate of growth and on the other this nonsense of investing into NOT guranteed whatever (annuities, bond for share funds). Then I can say I had a choice. This USA playing field has been criminal and good only for the GOP and the fat cats of Wall street. Give me true choice. Give me a choice between a federally guaranteed right to health care and my own private health care, see who likes what then.

[sandrarita]

While investing in stocks is a modern day means to increase wealth, all too often, investors are silent partners in supporting companies that are bad for America, for the earth and for people. There is nothing more hypocritical than someone claiming to be an environmentalist while holding stock in companies that pollute our air, water and earth. If investors put their money where their mouths are, instead of where their greed is, then we would be able to overcome global environmental devastation fairly quickly.

[Artos]

What I find ironic about the stock market is how they always seem to get bullish when they find out more people are getting laid off or fired. How is it that they can see the misfortune of others as a good time to profit. Also Stock Market investors are very fickle, they buy and sell on the slightest hint of a rumor. And finally I never believe stock market analysts or financial anaylysts who come on tv and tell us things because they never want to tell the truth. It isn't in their interest to tell us the truth. They tell us whatever will get us to sink more of our money into it even when they know that we'll soon lose it because they know that they will still make money regardless. I watch their eyes when they talk. When they blink alot or look aside as they say something, I know that they are lying. The other thing about the stock market is that it's just another method used by the rich to "borrow' our money or should I say steal it. Like they are right now. I don't necessarily think this stock market downturn is a coincidence. What better way to retake ownership of your Corporation than to get back all of your stock from the multitude of small investors.

[charleydan]

I trade in commodities(18 yrs). It is said, that 90% of all traders lose their tush. It is also said, most adivsory services are not any better. I have to agree. Since many of them do not trade themselves, they just give advice and collect your money.

If one buys a house and holds it for life. You know, your in it for the long haul, attitude. The value is lost by inflation. They find they can barely make ends meet when the house is paid for.
Stocks and commodities are no different.

If one does not enter at all. They will not even keep up with inflation.

Now there are those that look at a house and say, cheap, buy and sell shortly down the road. This is cycle buying. Or buying low and selling high. Not many seem to be able to see a good deal or make one, but for those that do. They get wealthy.

Inflationary-deflationary times. 18 of them since the creation of the Federal Reserve. Just makes it alot easier to create wealth for those that know. Why do you think bankers invented this on Jekyl Island and convinced government to buy into it?

In fact one of those bankers said a year earlier, Give me a nations economics and I will control that nation, Rothschild then formed Federal Reserve.

End the Federal Reserve and you will find you can buy and hold and make wealth.

Happy Tradings and Happy Thanksgiving

[research]

Outlaw Shorts.

Hedging doesn't work.

It motivates Hedgers to destroy companies: With Rumors.

[cylindar]

Well, as far as any investment goes, this is not the time. Long term investment strategies look very tricky at best. This means stay out of the markets and look for more solid investments when the dust settles. Get out while you can because generally speaking the losses for everyone will be substantial for more people than not.

[realist333]

Taken individually, these points are well made. But on the whole the ordinary investor has no business making quantitative judgements on the stock market.

There does exist a small class of sophisticated traders - and a "trader" is very different from an "investor" - who realize good profits in all market phases. This kind of trading requires skills comparable to brain surgery and takes about as long to master.

The rest of us will do best investing in one or more of the professionally managed funds. The well managed funds return a very decent dollar to their investors and, because the funds' performance is regularly published for all to see, it's not difficult to pick good ones.

[rwferr]

All I know is I got my 401k completely out of the Stock Market a year ago or more cause I knew exactly what was coming. Other people have lost their asses I have lost 2 percent. Tell me I made a mistake "timing the market"? I do not think so.

[CanuckDemocrat]

smart move, the market was at an all-time high about a year ago... it could only go down from there... I don't have anything in the market right now, but have been looking at exchange traded funds (ETFs) for when the market hits bottom and starts recovering. If there is anyone out there who pulled their money out, and then ALSO short sold some stocks, they would have made a killing.

[WIpatriot]

"Timing the market" is a term for when to buy and sell to maximize profit. Getting out is getting out. I got out completely almost 2 years ago. I could have stayed in a bit longer and "timed" my exit, and made a little more profit. But not losing any more of my savings was more important than not profiting enough. There are other places to invest other than the casino, er, stock market.

[NoLabelForMe]

You didn't make a mistake timing the market. Our host blogger (Mr. Solin) believes in passive index investing. Generally speaking, one cannot time the market EXCEPT when markets are expensive based on trailing P/E. What the average investor, and even "financial advisors" don't understand is that most equity returns are made when the investor buys low, sells high. Although cliche', the solution is simple.

When market P/Es are over 20, go to real estate or cash. In this case (the past year), the market was NOT expensive. But one could easily see the perfect storm brewing in the economy. Like you, my clients went to cash a year ago. Sometimes, one can practice active management. In this case, it paid off handsomely for both of us.

[dukeitout]

I don't think you "knew exactly what was coming" but I do congratulate you for losing only 2%.

[JustMyWords]

It looks like a good move now, but that's taking a short-term look at a long-term issue. You lost 2%.

But look at it another way. Those people you say "lost their asses" haven't actually lost anything unless they're selling at a loss. When the market goes back up (and looking back at history, it will), they'll not only not see a loss, they will in all probability see a gain, and probably a substantial gain. Will your 2% loss look so good then?

My fund currently shows about a 15% loss from last year. Yeah, that stinks. But most years, it's shown a 7-10% increase. It's still worth more than the actual money that was put into it, and by more than I could have gotten with a savings account or a CD. My loss over the past year is still a net gain.

[zahavi]

..."Remember, if you are buying, they must be selling. One of you is going to be wrong. Do you regard a 50/50 chance as good odds?"...

This is glib, superficial and incorrect. People and various institutions sell for different reasons. Some sell because they have no choice. They may be well aware that stocks will eventually recover, but are caught out by an immediate need. If you buy from them, neither one of you are "wrong" and the odds are very far from 50/50 that you will do well in the market.

Institutions have needs that differ from those of individuals. Open-end funds must sell to cover redemptions, even when the managers know that it is a bad time to sell. Even in good times, fund managers will sell to "hide the bodies" when they have made poor stock selections. The manager's career depends upon the appearance of success, not upon actually making money for his clients. The fact that they are selling for sufficient reasons does not mean your reasons for buying are wrong.

[Malakkar]

Further, 50/50 is workable odds, assuming you know how to manage your money. Any trader worth their weight can make a 50/50 system work for them, and be profitable. It's about asset management, not necessarily winning odds (though winning odds aren't bad!).

[rwinner1947]

>But over the past 82 years, periods of negative returns (six months or longer) have been followed by periods of positive returns, on average.

Isn't this a mathematical truism? The period of negative returns is not over until six months have passed that have a positive return. (A zero return is mathematically nearly impossible since the days before and after zero is hit are either positive or negative, assuming the markets are open.) If you had left out the phrase "or longer," then the statement is more interesting.

Or am I missing something here?

[DuganS1]

I don't know what "data" the author is referring to, but following economic data doesn't do any good either as the market to a large degree anticipates the data. You would have been better off in recent months if you followed the credit market data, but most investors either don't know what data to follow, where to find it, or what it means. Volatility had been a good way to make investment decisions in the past, but it hasn't been in recent months.

[ponderingmuch]

PART TWO:
People on HuffPo have suggested that a person like me should move somewhere that has reasonable housing costs. I live in Los Angeles, in a ramshackle but slightly charming one bedroom that costs $1400 a month. Look on craigslist. My place is actually pretty cheap for a grown-up here. Even the uncharming places cost that.

I became unemployed for a year and a half. To live, I cashed in all my stockes (which yielded about $8,000). And I am consumed now, with the difference between 'racked" and "wracked" regarding credit card debt. I think I 'racked' it. But maybe i 'wracked' it. But mostly, I am consumed with trying to pay off the $12,000 I, uh, amassed (accrues? racked up?) in credit card debt that changed rates and I can;t get any communication with those who raiseed the rates with no ability by me to do anything about it.

Please, pundits, help regular people by getting the credit card bailout banks be required to stick with rates and due dates they agreed to.

[NoLabelForMe]

I know your situation well. I've lived it over the past few years. You didn't indicate your income, but I assume it's inconsistent and fairly low. Some thoughts:

1. Mathematically, you're most certainly headed for a train wreck. You have to either fix the income problem (consistent work and probably more than 75K/year) or dramatically reduce expenses, or both.
2. Yes, you probably are wise to consider a locale such as Texas or the Midwest to reduce cost of living (primarily rents or real estate), as you might find your rent cut nearly in half. You'd have to sacrifice a great deal in quality of living, but it might be worth it to survive.
3. The credit card companies have a great deal of latitude to adjust your terms if they think you're going to default on your balances. Most have provisions they call a "hardship program" where they will lower your rates and minimum payment due for a period of time. For this you will likely be required to not use your credit card with them, in effect cancelling your card access, but retaining your account in good standing. I had been ill and let them know I was recovering from a serious illness and needed time to find work. They were very accomodating.

Best of luck to you.

[mamacat]

Would it be unreasonable to insist that the credit card holders, nationwide, lower their interest rates to something that does not qualify as usury?

[ElIngeniero]

I recommend Minneapolis. Cheap, pet friendly rentals abound.

[ponderingmuch]

PART ONE:
OK, but all this talk about people investing too much, stupidly, or buying luxuries on credit..all that sort of thing, are so profoundly out of tough with regular people.

From posting here I am discovering that I am a regular working person.

I am a prone-to-apoplexy cultural elitist, but financially I am firmly in the boat of the working-close-to-poor. I call it working-lower-middle-class, but I may still be kidding myself.

There are so many of us who work at jobs that pay no where near one fifth of our CEOs but also no where near minimum wage.

I, and I bet many others, have some credit card debt trying to pay for things like fixing the exhaust system on the '89 Volvo, buying ONE new pair of Birkenstocks (actually, I wear Ecco, but you get my drift). Also groceries, medical, dental, gas, eyeglasses, the absurd car rental when the old Volvo went out so we could get to work in a loction that just doesn't have the right public transportation.