On March 3, Joan and Bob called from Woodside with a request for a significant sale of their assets.
They had turned on the news regarding the Russia/Ukraine/Europe/U.S. developments, and had an immediate emotional reaction — sell!
Day in and day out, a good number of American investors deflate any semblance of successful investment strategy by emotionally reacting to financial sound bytes.
Several performance studies over the last 25 years indicate that the average investor severely lags the average mutual fund per year performance because of ill-timed buys and sells.
Consider the facts:
— Most investment buys and sells have transaction costs and tax consequences, reducing the ultimate performance of the investment.
— Many investors follow the herd by selling when they should consider buying. When was the last time you waited until your local store raised prices before you went in to buy? Many investors unwittingly do this.
— Behavioral Economics, as cited by the Harvard Magazine (Nov./Dec. 2013) indicates that our reaction to risk drives strong or weak financial rewards. Jones professor of economics Andrei Shleifer postulates that less sophisticated investors get unduly pessimistic about their investments and dump their shares on the markets, while other investors sweep in immediately and buy them up as “undervalued.”
— “Marketwatch.com/3.4.14” adds that the “typical mutual fund investor booked a 4.8 percent annualized gain over the last decade, while the typical fund gained an average of 7.3 percent a year.” The lost opportunity may be explained by emotional buying and selling.
Last week’s financial news, while long from over, may have been a classic case study.
On March 3, the Standard & Poor’s 500 Index fell 0.7 percent (the day Joan & Bob called). On March 4, the Standard & Poor’s Index gained 1.5 percent (opportunity lost for those who sold). What is this all about? The Ukraine makes up 0.2 percent of the global Gross Domestic Product (New York Times/3.4.14), hardly an economic force to deal with. Ukraine’s main economic attraction to the rest of the world is its production and sale of natural gas. It ranks only 33rd in the world in this capacity (www.cia.gov/library), again not overly significant. It is the psyche which drives our investment emotions; in this case, partially, memories back to the days of the Cold War. But, keep in mind that during a significant part of that Cold War, 1960-1970, the Standard & Poor’s 500 Index grew 54 percent.
Remember the Berlin Airlift? Where were you during the Cuban missile crisis? These were historically and politically important events, but savvy investors place these into perspective by keeping investment emotions under control.
In a 1966 movie, we were greeted by the wonderfully hysterical Luther Grilk, as he gallops through the slums of a small city on the U.S. East Coast, yelling “the Russians are coming … the Russians are coming.”
In an oddly humorous way it helped us understand each other’s positions as Alexei Kolchin explained: “In the Union of Soviet, when I am only a young boy, many are saying Americanski are bad people, they will attack Russia. So I mistrust American…”
Michael Graham, an employee of ours, reiterated it best in his recent study of Benjamin Graham’s “The Intelligent Investor” (widely regarded as the foremost book ever written on the subject of investing).
Ben Graham states, “The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. As an intelligent investor, the reader should avoid the speculative nature of attempting to anticipate market fluctuations.”
Bob and Joan are now calmed down. Steady the course!
Indices are unmanaged measures of market performance that do not allow for direct investment. Past performance does not guarantee future results. A stock’s or mutual fund’s valuation will fluctuate with market conditions and when sold may be worth more or less than purchased value. Information provided is not intended as a recommendation and should not be construed as investment advice. Please consult a financial professional before taking action. Allen Ostrofe, MBA, CFP®, AIF® is President of Ostrofe Financial Consultants, Inc., a S.E.C. Fee-based Registered Investment Advisor. Securities and Advisory Services offered through National Planning Corporation (NPC), member FINRA/SIPC, a Registered Investment Advisor. Ostrofe Financial and NPC are separate and unrelated companies. Visit ostrofefinancial.com. Branch address: 565 Brunswick Road, Ste. 15, Grass Valley.