Ever been on the “Market Timing Roller Coaster”? Many people find themselves drawn in by the allure of beating the market and end up on an emotional roller coaster of financial decision-making. A big surge in the market occurs, the roller coaster goes up and perhaps a bit of adrenaline and greed sets in and you think, “Buy!” Since what goes up must come down, the market sometimes dives, the roller coaster drops, fear takes over and you exclaim, “Sell!” Allowing emotions and investing to mix is a dangerous game and it often results in poor financial decisions being made.
Of the many variables that can influence the performance of a portfolio, for a lot of investors their behavior is probably the most important. Emotions can lead investors to take the wrong action at the wrong time. It is easy to stay disciplined and adhere to your financial plan when the markets are doing well, but it is much tougher to remain on course when the markets become volatile.
Most people are familiar with the investment adage, “buy low and sell high.” It’s a simple enough concept, but when human emotions get involved, simplicity often goes out the window. Knowing the precise time to buy and sell a stock is a rare skill. Most people end up executing trades at the wrong time and instead buy high and sell low.
The role that emotion plays in the success or failure of an investment strategy should not be overlooked. How do you put aside emotional urges and stay on track financially? It’s generally known that investors are highly unlikely to be able to exploit the market, and further that market timing usually results in lower returns than those generated from a buy, hold and rebalance strategy.
“How much did the average investor lag the average fund over the past 10 years ended 2012? A total of 0.95% annualized. The average fund returned 7.05%, but the average investor netted 6.1%. That’s a good chunk of the return.”1
So why is this? Shouldn’t investors be able to make smarter investment decisions with all the technology and information available today? It appears that the constant flow of information is actually causing more harm than good for the average investor by creating an environment where investors are inclined to buy and sell based on pure emotion.
The 2006 study, “All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors” found that individual investors buy stocks that grab their attention, meaning “stocks in the news, stocks experiencing high abnormal trading volume and stocks with extreme one-day returns.”2 Because investors are so overwhelmed with the many stocks to potentially buy, many investors consider purchasing only the stocks that really catch their attention.
The study found that the attention-driven buying patterns they documented “do not generate superior returns.” In fact, they concluded that “most investors will benefit from a strategy of buying and holding a well-diversified portfolio.”3
So how can you stay on track? Connecting with a financial advisor who can help you establish a long-term approach might help you maintain perspective and discipline over the long run. An advisor can help you to set clear, appropriate investment goals, develop a well-diversified portfolio, and minimize the overall investment cost.
Before you jump on the market timing roller coaster, keep in mind this nugget of advice, “Investors who insist on hunting for the next brilliant stock would be well advised to remember what California prospectors discovered ages ago: All that glitters is not gold.”4