It violates the most fundamental element of investing, yet thousands of investors practice it every day. As soon as the market or sector they are investing in loses ground they sell and go looking for the hot market. Eventually a new fund or sector with some strong recent gains is chosen to invest in and the investor is again confident that he or she is back on the fast track to riches. Then it happens again, an again and again. All the instruments they purchase have proven track records, yet their overall portfolio reflects a below-average return.
Or maybe the investor hopes to stay ahead of the game and pulls out of equities because the last two years have had significant gains and we are "due" for an adjustment. Then the next two years have even higher growth as the investor's money sits near idle in fixed accounts that barely keep up with inflation. So the investor decides he made a mistake and re-enters the market. The market becomes very volatile and the investor rethinks his decision. Now he goes back to fixed income securities with less money than he had before, and buys the same thing he held before for a higher price than he just sold it for.
This may sound like a bumbling investor, but study after study shows that he is probably average; an investor who makes emotional decisions, tries to time the market, or loses sight of his long-term goals. In other words an investor who has forgotten the "Three D's" of investing:
- Diversify: Don't put all your eggs in one basket or your money in one sector. As the economy expands and slows money has a tendency to flow back and forth between equities and fixed instruments. But inside these two markets exists a selection of sectors that also expand and slow with differing rates. This makes the proposition of timing the market even more preposterous since you have to time the smaller sectors against the broader sectors. The solution- Develop a portfolio that invests across a selection of sectors that match your overall accumulation goals with respect to your risk tolerance and time line.
- Dollar Cost Average: Dollar cost averaging is the systematic purchase of investment instruments over time. By buying an equal dollar amount each period, you should end up with a cost basis that is close to the average over that period. This is especially valuable in volatile markets where dramatic swings are experienced and diving in on the wrong day could be a significantly sobering event. However, with any investment program, there are no assurances of success. No investment program can guarantee a profit or protect against a loss in a declining market. And since dollar cost averaging involves continuous investment in securities, you should consider your ability to continue purchases through periods of low prices.
- Discipline: This is the single most important factor in avoiding the before mentioned traps. Although the market moves based on the economy, it can also swing wildly based on psychological reasons such as political turmoil, rumors on interest rate changes, or other world events. If the fundamentals of the economy still match your overall portfolio objectives then you stay the course. This is where the financial professional often becomes the deciding factor between the investor's success or failure to reach his or her goals.
Buying high and selling low is especially prevalent when the market takes a big loss. It is then that I provide the most value to my clients. When a nervous client calls I do two things. First, we go over the client's portfolio objectives and make sure the composition still matches the fundamentals of the economy. Then, if it does, I remind my client that
once the market goes down it's time to buy, not sell.
The author is a CLU and ChFC designee, a Registered Investment Advisor and registered representative of Jefferson Pilot Securities Corporation, member NASD, SIPC.