Showing posts with label illusory gain. Show all posts
Showing posts with label illusory gain. Show all posts

Friday 5 April 2013

Importance of Financial Education and Knowledge in Investing in the Stock Market

The tragedy is that people work so hard to earn money, and then they lose so much of it on the stock market because they haven’t taken the relatively simple steps to educate themselves about it.

First rule of Buffett: Do not lose money.


April 4, 2013
Mom and pop: The world’s worst investors
Commentary: They buy high, sell low, and the ending is predictable

By Brett Arends
Oh, brother.

I don’t know Mark Villa and Lucie White, a pair of doctors in Houston, Texas, who were featured in a big story in our sister publication, The Wall Street Journal, a few days ago.

And I wish them all the best.

But when I read the story about them, and other “mom and pop” investors rushing to jump back into the booming stock market, a few words crossed my mind.

The more printable ones included “Uh-oh” and “Doom.”

You know how, when you get older, the movies just get so predictable you can hardly bear to go any more? Within the first five minutes you can already tell how the whole story is going to end.

So I’m sorry, but when I read “Mom and Pop Run With the Bulls,” all I could think was, here we go again.

My Journal colleague Jonathan Cheng’s story tells you everything you need to know. Villa and White felt “sucker punched” when stocks collapsed in 2008, he reports. The crash “wiped out half their savings.” They sold out of stocks, put their money in the bank, and “swore off stocks,” presumably forever.

Last month, as the Standard & Poor’s 500 index surged to new highs, they hired a new financial adviser and plunged into the stock market again.

The problem with Villa and White isn’t that they are unusual but that they are absolutely the typical American investor. Both of them are doctors, meaning they are presumably intelligent and educated. And yet they insist on investing like absolute fools.

First, their minds have been playing tricks on them all along. The crash of 2008 did not wipe out half their savings, unless they invested all their money right at the peak and sold right at the bottom. The reality is that it wiped out a lot of illusory gains and replaced them with a lot of illusory losses. Stock prices were wrong in 2007 because they were too high, and they were wrong in late 2008 and early 2009 because they were too low.

Second, as they now know, they sold out somewhere near the lows. They were not alone. According to the Investment Company Institute, the trade body of the mutual fund industry, U.S. investors flooded the market with stocks in the fall of 2008 and the winter of 2009. From September, 2008 through March, 2009, ordinary U.S. investors dumped $114 billion worth of stock funds. They sold at absolutely the worst time.

This is not a coincidence. The stock market is “us.” Share prices fall because there are more sellers than buyers. They rise because of the reverse. So mom and pop investors like the Villa-Whites rush to dump their stocks because they see the market plummeting, oblivious to the fact that the only reason it’s falling is because people like them are rushing to dump their stocks.

And here we are in the opposite situation. The Investment Company Institute reports that mutual fund investors have pumped about $20 billion back into stock funds since the start of the year. Mom and pop investors across the country, just like the Villa-Whites, are rushing to buy stocks so they don’t “miss out” on big gains. The reality is that stocks have risen, in part, because people like them have rushed to buy stocks. And the more of them rush to buy stocks, the higher they drive the price.

Study after study has found the grim truth. People like the Villa-Whites end up losing money for years, even when the stock market has gone up, because they have sold at the wrong times and bought at the wrong times. They have consistently bought high and sold low. You could have made astonishing super-normal profits over the past thirty years just by selling stocks when Mom and Pop were buying, and buying stocks when Mom and Pop were selling.


Be like Buffett: Buy low and sell high.

Have you heard of Suicide Chess, a peculiar game where the rules are reversed and you try to lose all your pieces? Mom and pop investors like the Villa-Whites are playing Suicide Roulette.

The tragedy is that people like the Villa-Whites work so hard to earn money, and then they lose so much of it on the stock market because they haven’t taken the relatively simple steps to educate themselves about it.

There is no great mystery to the stock market. The longer I follow it, the less complicated it actually becomes. Buy stocks when they are cheap and everyone is afraid to own them. Don’t buy stocks when they are expensive and everyone is afraid of getting “left behind.” In other words, be fearful when others are greedy, and greedy when others are fearful. This is no great insight — Warren Buffett keeps saying it. The Villa-Whites were selling their stocks around the time Buffett was buying — and telling everyone he was buying too.

But the message just gets lost.

There are reasons for that. They include the Federal Reserve’s policy of Forever Blowing Bubbles, which has played havoc with the idea of the sensible long-term investor. They also include the spreading influence of a cult called the Efficient Market Hypothesis, which downplays the importance of the actual price you pay for stocks. It is horrifying how many financial advisers have bought into the nonsense of the EMH, often without even understanding it.

In late 2008 and early 2009 I was tasked by The Wall Street Journal with finding good value stocks for people to buy. And my job was very easy. There were so many cheap stocks around you could scoop them up with a spoon. Indeed in October 2008 I described it as “shooting fish in a barrel.” I was six months early, but so what?

Today it is very hard to find stocks that look great value, especially here in the U.S. And people like the Villa-Whites are rushing to buy stocks before they go to infinity.

I fear I have seen this movie before.

Brett Arends is a MarketWatch columnist. Follow him on Twitter @BrettArends.

http://www.marketwatch.com/story/mom-and-pop-the-worlds-worst-investors-2013-04-04