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Investor behavior once again prevents portfolio success
Guided by fear, most investors buy high and sell low rather than investing logically.
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To hear the pundits and so-called experts tell it now, it really was obvious that the markets were bottoming out last March. What goes down must surely come back up — we all knew that, didn’t we? So much so that on March 9, 2009 — the actual day the markets hit bottom, with the Dow just above 6,400 — a lead story in The Wall Street Journal headlined, “Dow 5000? A Bearish Possibility.”
Needless to say, the bottom was far from obvious. In fact, at the time, didn’t the markets seem almost bottomless? What were you thinking then? What did you do with your invested assets? Did you capitulate as the equity markets tumbled to new lows after the heartbreak of 2008? Or did you hang on by the very tips of your fingernails, hoping to survive the inevitable black hole the economy and the country were surely falling into? Each of us has a unique story to tell, I’m sure.
In my numerous articles on the mistakes investors make, and in my book, The Physician’s Guide to Avoiding Financial Blunders (www.slackbooks.com/avoidblunders [promo code 8A1735]), I have cited investor behavior as the main deterrent to long-term portfolio success. For example, in Chapter 2, I relate the analogy of shopping at Jim’s and Bob’s to the way investors behave. Jim is the one offering sales, while Bob offers only markups. Pay less or pay more? Then why in my analogy are more people flocking to Bob’s? Why are they willing to pay Bob’s higher prices and eschew Jim’s 30% sale, and how does this demonstrate investor behavior?
The answer is that the stock markets are the only markets where people wait until the price goes up to buy. They shop at Bob’s (at or near market highs) because it makes them feel better, and avoid Jim’s huge sales (at or near market lows) because they are scared. Instead of investing logically — buying low, selling high — the majority of investors, left to their own devices and guided only by their unbridled, media-fed fears, do the opposite: buy high and sell low.
How about you? How do you rate your behavior as an investor during the worst of the market decline, from September 2008 through early March 2009? And what did you learn about yourself?
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Now, you may be thinking that I am exaggerating the effects of investor behavior, and that people in the midst of the worst equity market and recession since 1981-1982 did not sell out or capitulate, especially like they did in 1987. Back then, like the violent eruption of Mount St. Helens that blew away its summit, the market crash on Oct. 19 blew out more than 22% of the stock market value. There was no one-day, 1987-like investor panic in 2009, but if we are to believe the recently published results of the purportedly best mutual fund of the past decade, then harmful investor behavior is alive and well.
Warning: You should be seated while reading the following data. In his article, “Best Mutual Fund of the Decade: CGM Focus,” (http://www.theresilientinvestor.com/2010/02/best-stock-fund-of-the-decade-cgm-focus/) writer Ted Toal relates the difference between the investment returns of the CGM Focus Fund and the returns its average investor achieved in the last decade, through January 2010. Similar to the investor behavior studies previously published by the Dalbar Institute, according to Mr. Toal, Morningstar measured how well investors in the CGM Focus Fund did compared to how the fund itself performed during the last decade. Remember now that CGM Focus was the best fund of the last decade. Here’s the heart of the data, the 10-year annualized results through the end of January 2010:
- CGM Focus: +18.03%
- Typical CGM Focus investor’s return: –13.73%
That represents a dramatic difference between what the fund accomplished and what the typical investor in the fund received. But how can it be that the fund gained 18.03% while the typical investor lost 13.73%?
The answer is that many CGM Focus investors shopped at Bob’s, not at Jim’s. They were lured in by the +80% returns the fund sported in 2007 and the positive media exposure that followed, and they bought high. According to Morningstar, the money poured into CGM Focus in 2008 to the tune of $2.6 billion of in-flows. Then, that same year, the fund followed the markets in decline and plunged 48.2%. How did investors react? Many made the big mistake and “yanked more than $750 million out of the fund,” according to Toal. In other words, many CGM Focus investors sold low. Those investors who bailed out missed out on the 2007 gains and bore the brunt of the –48.2% freefall in 2008. If investors sold during the 2008 decline, they failed to capture the +10.42% recovery of the fund in 2009. This is how investor behavior can defeat even the best of investment fund choices, such as the CGM Focus Fund, the best fund of the decade.
If you stayed invested throughout the dark days of 2008-2009, then pat yourself on the back. You did so in the middle of one of the most perfect investment storms in decades. You recognized that a market decline does not mean you have suffered a permanent loss. A paper loss maybe, but not an irrecoverable one. Perhaps you even rediscovered Jim’s store at the beginning of 2009 and bought into the falling markets. If you did, you may have experienced the recovery off the market bottoms.
If you did not fare so well during 2008-2009 and found yourself, like many CGM Focus investors, making the wrong investment decisions at exactly the wrong times, perhaps you need to seek out objective advice from an experienced investment counselor. If you sold out and are still sitting in cash or CDs now, afraid of reentering the equity markets, perhaps you need a qualified investment guide to assist you. Long-term portfolio success cannot sustain itself on 0.5% cash or money market returns, or even 2% CD returns, when taxes and inflation suck out the purchasing power of those dollars as surely as the markets rise and fall. If your behavior short-circuits your portfolio success, as does shopping at Bob’s, take that variable out of the equation. Bite the bullet and find help. Both you and your portfolio will be the better for it.
Past performance is not a guarantee of future results.
If you send me an e-mail (see address below), I will send you a copy of the original article I wrote on shopping at Jim’s and Bob’s.
Ken Rudzinski, CFP, CLU, ChFC, CRPC, CASL, CAP is a registered representative of Lincoln Financial Advisors, a broker/dealer (SIPC) and a registered investment advisor. He can be reached at 2036 Foulk Road, Suite 104, Wilmington, DE 19810; 866-529-1320; e-mail: kenneth.rudzinski@lfg.com. CRN 201003-2039676.