The Ignorant Investor
Ignorance Can't Stand in the Way of My OpinionMonday, June 13, 2005
I am an ignorant investor
It seems worthwhile to begin a blog about ignorant investing (the only financially-related subject with which I am familiar) with a post about just how poorly the average individual does in the role of portfolio manager.
In a post on Sunday on his market-oriented blog The Big Picture, Barry Ritholtz, the chief market strategist for Maxim Group, linked to the results of a study that found that:
Ritholtz links these low returns to a tendency among individual investors to allow the dominance of emotion over rationality. They succumb to a herd mentality that makes them buy stocks only when everyone else is buying, he says, and sell stocks only when everyone else is selling theirs. The result is a de facto trading strategy that can be aptly summarized as "buy high, sell low." Obviously, that's not the easiest way to make money.
I don't know if Ritholtz has it right here. I'd like to say that I am as canny an investor as they come. Yet my own experience in investing has been governed by emotion, largely alternating between fear and greed. Envy, too, has occasionally put in an appearance.
For example, after the 2000 crash, I fixated on maintaining a huge position in cash. At the time I was worried about a serious market crash. Dow down to 4000 or so, economic meltdown. The works. This is what happens to an otherwise rational mind when it sees its portfolio lose 40-50% of its value in the course of a year or two. Fear takes over, and the result was that I missed out on the huge 2002 rally after the market touched its low in 2002.
Move forward a couple of years. Now that the S&P is running high again, I've become obsessed with the idea that I missed out on what turned out to be a sizable gain. My gut tells me that the market is going up more, and so now I'm more worried about missing out on gains than I am of losing capital.
Yet should I be listening to my gut?
My gut is no more able to pass judgment on the future course of the market than it is able to solve a complex math equation or write a light opera. Those are tasks for the brain. For an organ capable of weighing evidence, imagining possible movements in stock prices, and judging the probability of those outcomes occurring. In other words, the decision of whether to invest in the S&P or some other investment vehicle shouldn't go by instinct. It should be based on reason.
Now that certainly appeals to the highly trained, analytical side of my brain. But if people were entirely rational, no one would be afraid of flying, we wouldn't fall in love with someone we shouldn't, and very few jokes would be funny.
So when I hear on CNBC an analyst say something like "a lot of cash is waiting on the sidelines to leap into the market", I can't help but be lured by that sweet siren's call from the S&P . . . buy me . . . invest now . . . don't miss out . . .
In a post on Sunday on his market-oriented blog The Big Picture, Barry Ritholtz, the chief market strategist for Maxim Group, linked to the results of a study that found that:
“Individuals have historically underperformed the markets, earning just 2.6% vs. the S&P 500 gain of 12.2% between 1984 and the end of 2002. Research in the U.S. has shown that this dramatic underperformance comes as a direct result of client behaviour, or more specifically, the attempt to avoid bad performance while seeking out better returns.“http://bigpicture.typepad.com/.
Ritholtz links these low returns to a tendency among individual investors to allow the dominance of emotion over rationality. They succumb to a herd mentality that makes them buy stocks only when everyone else is buying, he says, and sell stocks only when everyone else is selling theirs. The result is a de facto trading strategy that can be aptly summarized as "buy high, sell low." Obviously, that's not the easiest way to make money.
I don't know if Ritholtz has it right here. I'd like to say that I am as canny an investor as they come. Yet my own experience in investing has been governed by emotion, largely alternating between fear and greed. Envy, too, has occasionally put in an appearance.
For example, after the 2000 crash, I fixated on maintaining a huge position in cash. At the time I was worried about a serious market crash. Dow down to 4000 or so, economic meltdown. The works. This is what happens to an otherwise rational mind when it sees its portfolio lose 40-50% of its value in the course of a year or two. Fear takes over, and the result was that I missed out on the huge 2002 rally after the market touched its low in 2002.
Move forward a couple of years. Now that the S&P is running high again, I've become obsessed with the idea that I missed out on what turned out to be a sizable gain. My gut tells me that the market is going up more, and so now I'm more worried about missing out on gains than I am of losing capital.
Yet should I be listening to my gut?
My gut is no more able to pass judgment on the future course of the market than it is able to solve a complex math equation or write a light opera. Those are tasks for the brain. For an organ capable of weighing evidence, imagining possible movements in stock prices, and judging the probability of those outcomes occurring. In other words, the decision of whether to invest in the S&P or some other investment vehicle shouldn't go by instinct. It should be based on reason.
Now that certainly appeals to the highly trained, analytical side of my brain. But if people were entirely rational, no one would be afraid of flying, we wouldn't fall in love with someone we shouldn't, and very few jokes would be funny.
So when I hear on CNBC an analyst say something like "a lot of cash is waiting on the sidelines to leap into the market", I can't help but be lured by that sweet siren's call from the S&P . . . buy me . . . invest now . . . don't miss out . . .
posted by Worker 17 # 1:38 PM 
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Your gut has evolved to do other things; In fact, the capital markets is the LAST thing its good for.
Read this and you'll have a better sense of what I mean:
You Just Ain't Built For it
Let me know if that clarifies things any . . .
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Read this and you'll have a better sense of what I mean:
You Just Ain't Built For it
Let me know if that clarifies things any . . .
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