Investors can make many mistakes during their investment lifetimes: not starting early enough, not investing aggressively enough, investing too aggressively, not being diversified enough etc…. In my experience there is no bigger mistake that one can make than the “big mistake”.
That’s the term we give to the investor who sells after a substantial decline and then watches the market go back up, afraid to invest again.
The data supports my conclusion that investors are simply lousy at timing the market.
According to Morningstar, investors have missed out on nearly 1.8% per year over the past decade and 1.6% per year over the last 15 years by selling low and buying high. They measure this by using investor return and comparing it to the fund return. Investor return is often called the dollar weighted return because it weights the return by the amount of dollars in the fund. The Investor’s return is lower than the fund return because investors sell when the fund is down, leaving fewer dollars to participate in the rally.
The real problem with selling low is trying to justify buying as the market continues to rise. Some don’t and continue to earn nearly 0% on their cash. Others buy just before a top and repeat the cycle all over again.
How can I prevent this?
Having an experienced financial advisor guide you through the emotions of a decline (fear) and rapid rise (greed) can help you make rational investing decisions. However, you should have a plan that anticipates a sharp market decline. We’ve had them before and we will have them again. Having the discipline to reduce your risk when times are good and increase your risk profile when the market declines can help with your emotions too.
Volatility is here to stay. How you choose to manage the ups and downs of the market will determine your success as an investor.