Why Most People Suck At Investing

Sep 15, 2014   //   by Profitly   //   Market, Profitly, Psychology  //  Comments Off on Why Most People Suck At Investing

Guess what. Most people are HORRIBLE at investing. That’s right, most people do a terrible job of picking out which stocks or sectors will rise and which will fall. You may or may not have heard this before, but it shouldn’t come as a surprise.

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Image via glogster.com

A recent article by Business Insider dove in to just how bad most people really are when it comes to investing.

First and foremost, one big problem is that investors often find themselves buying at highs and selling at lows, especially when volatility picks up and patience is tested. The problem is that so many people keep holding a stock for far too long, thinking it will turn around and move in the direction that they want it to. They then become emotionally invested in it and blind to the reasons that it WON’T move in their direction. If you follow our gurus’ rules and limit your losses, you have less of an attachment to the stock and will be able to make better decisions. You still won’t buy at the very lowest and sell at the very highest, but you buy lower than you sell and still net a profit.

“Amidst difficult financial times, emotional instincts often drive investors to take actions that make no rational sense but make perfect emotional sense,” said BlackRock back in 2012. “Psychological factors such as fear often translate into poor timing of buys and sells.”

Richard Bernstein of Richard Bernstein Advisors considers twenty years of historical data for this in a new research note.

“The performance of the typical investor over this time period is shockingly poor,” wrote Bernstein. “The average investor has underperformed every category except Asian emerging market and Japanese equities. The average investor even underperformed cash (listed here as 3-month t-bills)! The average investor underperformed nearly every asset class. They could have improved performance by simply buying and holding any asset class other than Asian emerging market or Japanese equities. Thus, their underperformance suggests investors’ timing of asset allocation decisions must have been particularly poor, i.e., investors consistently bought assets that were overvalued and sold assets that were undervalued.”

Bernstein’s data is based on the buying and selling activity of mutual fund investors.

“They bought high and sold low,” he added. “When chaos occurred, investors ran away.”

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None of our gurus get 100% of their trades right, but you’ll hear them preach over and over again that the driver of their success is limiting losses. The famous economist John Maynard Keynes once said “Markets can remain irrational longer than you can remain solvent.” It basically means that your investment thesis could be completely right, but the market may not realize that until you’ve been forced out of your position due to massive losses. I don’t think any of us could have said it better ourselves.

For example, Tim could be shorting the crappiest company out there, but if mailers continue to go out at a record pace, the stock could continue to climb considerably higher. That’s why Tim cuts losses quickly and is always prepared to make a trade at a moments notice. Losing $1000 on a trade isn’t a big deal for him, but losing $100,000 on a trade would be. With the small loss, you move on and simply get prepared for the next pattern to present itself.