BUY LOW & SELL HIGH: The first rule of investing, right?

 

by David Novak

For the average investor, buying low and selling high is a lot easier said than done. A study last year by research firm Dalbar found that in 2014 the Standard & Poor’s 500 stock index delivered a total return of 13.7%, while the average equity mutual fund investor achieved a return of only 5.5%.

If a longer view is taken, do investors fare any better? Unfortunately, no. For the 20 years prior to December 31, 2014, the S&P 500 had an average return of 9.9% per year, while the average return of stock mutual fund investors was only 5.2%.

What accounts for this staggering difference? As one would expect, it is mainly a result of “bad behavior”- i.e. buying during euphoric markets (high) and selling during volatility and panic (low).

Digging a little deeper, one of Dalbar’s additional findings was that these gaps in performance were most significant during market inflection points. For example, in October 2008, the S&P 500 lost 16.8%, while the average stock investor lost 24.2%. Other notable gaps occurred during months with sharp market rebounds, such as in March 2009.

Inexperienced or unsophisticated investors might believe that they can “time” the market; in other words, sell when everything looks uncertain and the market is volatile, and then buy back in when the economy and market appear to be in better shape. The problem with this approach is that markets are discounting mechanisms, in that prices reflect all currently known information. So by the time the “coast is clear” and it appears to be a safer time to invest, prices have already enjoyed a meaningful rebound.

Investors may find it ironic that a period of maximum panic such as March 2009 was actually one of the “safest” times to invest in stocks, since stock prices were reflecting a doomsday economic scenario. Along the same lines, periods such as March 2000 or October 2007 – when market volatility was low and the seas appeared to be calm – were actually a more “dangerous” time to invest, since stock prices were at an inflated level.

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Do the numbers look any different when looking at the bond market? In fact, the performance gap is even worse. The same Dalbar study found that the average fixed income mutual fund investor earned a return of 1.16% in 2014, while the Barclays Aggregate Bond Index returned 5.97%.

This is especially staggering given that the role of bonds in a diversified portfolio is to provide stability of principal, and preserve its value during times of stress in the equity market.

For me, this brings to mind the old quote from Warren Buffett, “The most important quality for an investor is temperament, not intellect… You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”

Unfortunately, the data has shown time and again how difficult it is for the average investor to accomplish this, and stay focused on their longer term investment plan.

David Novak, CFP® is a Certified Financial PlannerTM at Novak & Powell Financial Services in Pinellas County. Please note: Mr. Novak is not an attorney and this article should not be construed as one offering legal advice. For information about investment decisions and financial planning, email david@novakpowell.com.

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