Editor’s note: This article was first published in April 2013; the Apple share prices it quotes ($700 in late 2012 and $390) predate the company’s 2014 and 2020 stock splits, and the 2012 Bankia collapse is cited as a recent example.
The principle of stock market investing is very simple: “Buy low, sell high.” At least, that would be the ideal. Unfortunately, most investors tend to do the opposite of what would be right, and that’s why many people think the stock market is very risky and that investing in it is very dangerous.
It used to be said that retail investors lost money because they didn’t understand what stock market investing was about. Today we could say they lose money by following the advice of the people who do understand the stock market. What’s more, it isn’t only beginners who make bad decisions, as we’re about to see along with some statistics… and, of course, I’ll give some advice again so that a few points are clear once and for all.
A chart from BlackRock shows mutual fund flows compared with the S&P 500 between 2000 and 2010. We keep repeating that the secret of the stock market is to buy when it’s cheap and sell when it’s expensive, yet the chart shows that money flows into funds slowly when the market is down and very heavily when the market is up. It could be a chart of any index, since the same thing happens with investors in indexes all over the world.
This would also explain why most mutual funds don’t make money for their clients, or why the returns they generate are well below what investors expect. Investing this way is chasing negative performance, but it’s very common for a large share of investors to do it, because most investors fish in the same rivers.
According to a recent study by Longboard Asset Management, these were the blunder rates of some 5,000 retail investors between 1983 and 2007. In other words, the investors bought a wide range of stocks and, for the most part, either picked the wrong stocks or bought them at the wrong time.
- 40% of the stocks the investors picked were unprofitable investments. They chose stocks that, instead of rising as they expected, started to fall, some quickly and others less sharply.
- 19% of the investors bought stocks that ended up losing 75% of their value. This group would include shareholders who bought Bankia and the like.
- 30% of the investors bought stocks that made money, although less than the index.
- 11% picked the stocks responsible for most of the market’s rise. In other words, they chose winning stocks.
From these figures we can draw one conclusion: when you invest in the stock market, there’s a 59% chance that you’ll get either the timing or the choice of stock wrong, plus an additional 30% chance of taking on high risk for a return that’s too low or below what you expect.
Why?
There’s a piece of advice I hear a lot: “Don’t try to guess what the market will do or get ahead of it. Follow the market.” To some extent I agree, but on the other hand that’s what makes us mediocre investors or leads us into one of the risky phases of a bubble. Let me explain.
Is there any doubt that the best investors in history have built their success on spotting undervalued stocks? In other words, buying what everyone else is selling, or going against the trend.
People were advised to buy Apple when it was trading at $700, and investors bought it. Now they’re advised to sell at $390, and investors are selling. Wouldn’t it be better to buy now? Apparently not: most will buy Apple once it climbs above $550 again, and I’m sure that, just today, some of those who bought above $600 have sold below $400.
The main concept of investing is the one that runs through three articles we’ve already published. Not surprisingly, all three are about the advice of the investing masters:
- 1. Lessons from the few investors who beat the market
- 2. Warren Buffett’s 16 investing guidelines
- 3. Lessons from Benjamin Graham
See also: 5 questions to ask before making your first stock market investment
Featured image: US-gov, Public domain, via Wikimedia Commons.
