Whether the stock market is soaring or sinking, investors find ways to fool themselves. This goes for typical small investors (which describes most of us) as well as for investing enthusiasts and even investing professionals. We’re all human, and what we tend to do as investors is exaggerate our skills…embellish our performance…and blame invisible forces for our misfortunes. After all, we don’t want to chalk up our successes to dumb luck or take full responsibility for our failures.
That tendency has remained in force over the past several years as stock prices have quadrupled since bottoming out in 2009. We all want to feel good about our investment results and make ourselves look good to friends and family. That’s tough to do if we’re totally honest, so we shade the truth and cook up dubious justifications.
But that could make it harder for us to hone our investment skills and avoid missteps in the future. Here are seven comments I hear from investors all the time—and how you might benefit from being more honest about your investment habits…
“Even when the stock market was down more than 50% and everybody was panicking, I knew all along that stocks would bounce back.” You might know the old saying that even a broken clock is right twice a day. Many of us are not that different from that broken clock. We ignore our incorrect or foolish forecasts from the past, remembering only the correct ones—and perhaps we even rewrite history, so that we recall buying stocks when we actually were selling. All this can make us think we’re smarter about investing than we really are.
For a reality check, go back and look at your financial statements. In particular, I would focus on the trades you made in late 2008 and early 2009, when share prices were plummeting. This was probably the buying opportunity of a generation.
Were you selling? That tells you that you don’t have a high tolerance for investment losses and that you might benefit from using a fee-only financial adviser. To find an adviser, check GarrettPlanningNetwork.com…NAPFA.org…or Vanguard Group’s Personal Advisor Services.
“I will buy when stock prices go back down.” Many investors are sitting on too much cash and kicking themselves for not owning stocks. But it’s time to face the truth. Share prices likely will never return to the depressed levels of 10 years ago.
Want to get back into stocks? Try this strategy: Figure out how much of your money you want in the stock market. Plan on investing 1/36th of this amount every month for the next three years. That’s a very conservative schedule. If stocks drop by 15%, double your monthly investment. If they drop by 25%, triple the amount.
“I’ve beaten the market.” When people tell me that they have outperformed the market, I don’t think they’re lying. But I strongly suspect that they don’t know the truth.
The math of investing is brutal. After investment costs, most people fail to beat the market averages. Yes, you might get lucky this year. But investment costs eventually take their toll, and it’s highly unlikely that you will beat the market over five years, let alone over a lifetime of investing.
So how can people possibly claim they’ve beaten the market? Often, they focus on the investments they’re proud of and ignore the rotten ones they regret, and then they compare their investment performance to some vague recollection of how the broad market performed.
My advice: Closely track your portfolio’s performance. If you find your investments regularly lag behind the market, bet on the overall market instead—by buying index funds. For broad US stock exposure, consider the following funds—Fidelity Spartan Total Market Index Fund (FSTMX)…Schwab Total Stock Market Index Fund (SWTSX)…and Vanguard Total Stock Market Index Fund (VITSX).
“My retirement account has doubled over the past three years.” That sounds impressive. But how much of the growth was because of investment gains—and how much resulted from new contributions?
To find out your true performance, check whether the custodian of your 401(k), IRA or other account provides your “personal rate of return.” This will tell you how your investment picks have performed, taking into account when you bought and sold.
You then might compare your performance to the results of a target-date retirement fund that has a stock-bond mix similar to what you own. These target-date funds, which are well-diversified portfolios geared to folks who expect to retire at or around the year specified in the fund’s name, are a common investment option in 401(k) and other retirement plans. Not beating the target-date fund? Maybe you should ditch your current portfolio and buy the target fund instead.
“The stock price will go back up.” Investors often are described as risk-averse. But that isn’t strictly accurate. Instead, we are loss-averse—meaning that we hate the idea of losing money.
For instance, if we buy a stock and it plunges in value, we call it a “paper loss,” which implies that the loss somehow isn’t real. We refuse to sell, because that would force us to admit that we made a mistake and give up all chance of recouping the loss.
Selling often is smart, especially if you hold the losing stock in your taxable account. Each year, you can use realized capital losses to offset realized capital gains and up to $3,000 in ordinary income on your federal income taxes.
“This rally has further to run”…or “This rally won’t last much longer.” After nearly 10 years of rising share prices, some investors are extrapolating the market’s performance and assuming that shares will keep on rising. Others think exactly the opposite. Instead of betting that the market’s trend will continue, they assume it will reverse—and that stocks are about to plunge.
Investing is a nerve-racking endeavor, with big money at stake, so it’s understandable that investors want to know what will happen next. But such predictions are no better than calling heads or tails on a coin flip, and they could cause great damage if they spur us to make big portfolio changes. Those changes could leave our portfolios badly positioned—and they might trigger hefty trading costs and big tax bills.
“I’ll get out before the next crash.” As our portfolios grow fatter, we grow more confident and feel like we’re ahead of the game. That might spur us to move even more of our money into stocks, trade more and buy more aggressive funds.
But instead of taking more risk, we probably should grow more cautious as our portfolios grow fatter, because nobody knows when the next bear market will hit. After the strong stock market gains since 2009, some investors will find that they have, say, 80% in stocks when their long-run target is 60%—and this might be a good time to rebalance back to 60%.