What was the proper investment move to make during the past year, when the stock market fell, rose, fell again and rose a second time?
With that question in mind, the headline of a recent Wall Street Journal article caught my eye: “How to Stop Killing Your Returns.” The same article was titled “The Big Mistake Investors Still Make” a day earlier online. Something is “killing” your returns?
You might think The Journal provided a secret antidote — a new market timing technique or an update to Modern Portfolio Theory. But, no. It shared something that I have espoused for years: Stay invested.
Let’s take three questions, and show how this works.
Sell when markets seem to be tanking?
Stocks have been on a rollercoaster ride. Last year’s August-September 8% drop in the S&P 500 index caught many investors by surprise. Then, October had an 8.4% gain. In January, the S&P 500 index fell nearly 5%. It stayed flat in February, but surged more than 6.5% for the month of March.
“Moves like this drive investors crazy, often causing them to trade their holdings in damaging ways,” The Journal said.
The Journal cited data from Morningstar, an investment research company. The data reveal that investors in diversified U.S.-stock funds missed nearly 1.8 percentage points of their funds’ annualized total returns over the past decade.
How can someone have worse performance than the fund they’re invested in? It’s possible by trading in and out of funds, missing gains rather than have the money invested over the entire time period. It happens all the time.
What causes this trading behavior? Fear.
Fear makes investors sell stock fund shares when the market is low, and then buy them back later when things have calmed down and prices are up.
“If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure),” said Warren Buffett, chairman of Berkshire Hathaway, in his 2014 letter to Berkshire shareholders.
Try to time the markets?
In fact, investors are getting worse at timing their trades. The Journal reported that the gap between mutual fund performance and investor performance over the past 15 years is -1.6 percentage points. Remember, it was -1.8 percentage points for the past 10 years. It means that investors lately have tried to time the market with especially poor results.
The solution is to stay invested. That sounds simple enough, doesn’t it?
I’ve advocated buying and holding for years. In the 1980s and ’90s, I taught continuing education classes on investing. I drilled into my students the idea that the markets can be fruitful. Most investors don’t realize the gains that can be achieved by staying invested. And, most investors don’t realize their tendency to make emotional decisions.
- When stocks are doing well, most people can’t invest fast enough.
- When stocks are doing badly and investors see their account balances plunging, they want out quickly.
We’ve all known people who say they want to wait until stocks improve before they invest. The problem is that we never know when the market will fall and when it will rise.
The Morningstar data show that most investors are late in getting out of stocks and late in getting back in.
Think about that. People sell shares of stock funds when the net asset values are low. Then, they buy the shares back when the values are high. If someone had suggested that they sell low and buy high, they’d be laughed out of town. But when emotions rule, that’s precisely what many investors do.
Let a robot invest for you?
If buying and holding is so simple, why don’t more investors do it? The answer is, human nature. Fears, frailties and foibles come with our species.
Some time ago, I wrote about the possibility of robo-advisors one day replacing human beings as advisors. Could this work? Probably not, because emotion-laden humans need other humans to be the voice of reason. Machines can’t tap you on the shoulder, look you in the eye and say, “It’s going to be ok.”
When the urge to sell some good investments at a bad time hits you, talk to a qualified human advisor.
Sometimes, life’s biggest questions have the simplest answers. Turns out that applies to investing. Remember,
- Don’t jump in panic and sell.
- Don’t try to time the market.
- Find a qualified advisor for help, someone you can talk to.
Now, how is the S&P 500 doing today? Oh, never mind.
Note: The historical performance figures for the S&P 500 Index are for illustrative purposes only and are not intended to imply or guarantee future performance. The S&P 500 (Standard & Poor’s 500) is an unmanaged group of securities considered to be representative of the stock market in general. The index cannot be purchased directly by investors. Returns are average annualized returns. The illustrations exclude the effects of taxes and brokerage commissions or other expenses incurred when investing. These returns were the result of certain market factors and events which may not be repeated in the future. Past performance is no guarantee of future results.