Investors Behaving Badly — Do You Recognize Yourself in the Lineup?
Back in the 90′s there was a comedy series entitled, British Men Behaving Badly which basically depicted the drunken life of two roommates who acted like a couple of two year olds. The title must have been pretty compelling to producers, because it resurfaced in 2002, when the Oxygen network had a three year run with a reality show called, Girls Behaving Badly.
I think if we got together in the investment world, we could come up with a few reality shows of our own. Investors Behaving Badly could depict the real life irrational thinking patterns of individuals who confidently fill out their risk profile questionnaire, determine a strategy for investment success, and then quickly cave under the first signs of pressure.
Here’s our predictable cast of characters. Do you recognize yourself in any of the following?
The Buy-High / Sell-Low Investor:
The star of our show, unfortunately, is the investor who is lacking the basic, yet required ability to maintain a steady, long-term course, despite fluctuations in the market. The buy-high, sell-low guy goes against the first rule of investing, which is, of course, to buy when prices are down and sell off gains when stock prices rise.
Okay, it’s pretty easy to simply point out this wrong thinking. We all know this is backward. Let’s look at the reason why some investors partake in this bad behavior.
This type of investor hasn’t yet learned to discipline himself and acts on feelings of anxiety and fear. In his defense, financial advisors looking to push products have helped to condition this investor for failure. Touting past performance and market timing capabilities, many financial advisors offer ill advice that produces a false sense of security in certain investments. When expected returns don’t materialize or the market takes a dive, the first instinct is to take what marbles he has left and go home.
The solution for the buy-high, sell-low investor? Knowledge of how markets really work and the ability to stay on a proven course are key factors. I believe many investors crumble under the pressure of fluctuations in the market, simply due to the fact that they are not fully persuaded (through proper and available data) that markets are efficient and continue to perform over time. The temptation to bail out is high when prices start to tumble, but if an investor has a properly constructed portfolio, the best plan of action is to ride out the low periods, knowing that missing the upswings will only bring additional grief.
The Non-Diversified Investor:
The next investor in our lineup is the guy who thinks his portfolio is properly diversified just because he has tacked on a small allocation to an international stock or added a few bonds. Basically, this investor doesn’t fully understand how to properly diversify his portfolio. Diversification involves several key factors that need to be decided first. These factors include an investors financial goal, a projected timeline for achieving that goal, and risk tolerance.
Once those three factors are decided, diversification makes more sense. In simplest terms, a diversified portfolio will spread money across different classes of investments in order to minimize risk by reducing the fluctuations of returns. This is accomplished by spreading investment dollars across sectors that don’t track together. When one begins to drop, others will reduce the potential loss because they won’t fall at the same time.
Many investment strategies can be learned and understood through real life business situations. Let’s say you own a convenience store near the beach. When your store first opens, you sell the basics for an enjoyable day in the sun. These items include sun screen, towels, beach toys, and other sunny weather things. After a while you notice that on rainy days you aren’t selling anything at all. These days are quite a loss and are affecting your bottom line. In order to minimize your losses, you may choose to carry items people look for when unexpected storms or problems arise, so you start to carry umbrellas, rain ponchos, first aid kits, aspirin…you get the picture. Sure, maybe you aren’t having stellar sales days when it rains, but you are finding a way to offset your losses by offering items that are purchased at different times. If you understand this, then you understand the basics of diversification. Investments that don’t track together are key to a properly balanced portfolio.
The Market Timing Investor:
We all know this character. He’s the one who pours over the statistics looking for trends and probabilities that will provide him with a winning hand. I say “winning hand” because the market timing guy is essentially gambling with his investment dollars. No one can predict the future and regardless of how sound a company or investment may appear, one catastrophic event or newsworthy change in corporate hierarchy can send a market timer into a stress induced frenzy.
Take for example the recent resignation of Steve Jobs from the Apple corporation. This news, coupled with the fact that Apple shares dropped directly following this event could send a market timer down a path of speculation. Looking at Apple’s inside trading over the past year, an investor could draw some conclusions. William Campbell, former Apple VP of marketing, sold off 3 million dollars of shares just a month prior to Job’s resignation. Going deeper, there haven’t been any insider purchases over the past 12 months, only sell offs. What could this mean? Armed with this information, a market timer could decide it’s time to pull out of Apple stocks, which by the way, returned to normal levels within two days after the CEO change.
We could use plenty of other examples of the market timer. The bottom line here is this: Instead of trying to time the market, predict the future, or figure out what is going to happen next, the prudent investor will properly diversify his portfolio to minimize potential loss, rely on the market to perform, and stop chasing the news. When you have a plan in place, you can live your life, enjoy your family, and stop obsessing over “what might happen.”
The Hot-Stock Chasing Investor:
Last, but not least, we have the investor who just can’t stop himself from following the crowd. Yes, that’s the way we are wired as humans. If everyone is doing it, it must be good. No one wants to miss out. Unfortunately, when it comes to investing strategies in general, this is a bad idea. Why? First of all, most crowds follow hype created in an effort to boost stock prices.
Again, as we always advise, a properly weighted portfolio and self discipline are key. When things are going well, financial advisors and investors alike may be tempted to throw caution to the wind and buy in areas that are hot. The trouble with this is the fact that by the time something is considered hot, it has probably already had its run. So, what happens? Once again, investors fall into the trap of buying higher than they should and then pulling out when the prices start to fall.
Do you recognize yourself in any of our Investors Behaving Badly all-star cast? The best way to avoid falling into any of these unfortunate investment strategy traps is by having the correct plan in motion and sticking to the plan. Turn off the news, stop checking stock highlights multiple times per day, and stop acting on emotions. Grab your free copy of 7 Deadly Traps of Investing and learn how to adopt and stick to a prudent investment strategy that you can work with…instead of against.
Bryan Binkholder, The Financial Coach, is a registered investment advisor, motivational speaker, and catalyst for change in the financial industry. With a true passion to make a difference, Bryan offers practical insights on financial topics, investment strategies, and business success on his weekly radio broadcast, The Financial Coach Show. Be sure to take advantage of his free resources, and check out the audio archives of his broadcast.