When Investing, You Can Be Wrong Even When You Are Right

There are many things I love about my job. One of the highlights is speaking with financial advisors across the nation, sharing stories and discussing challenges. This last fall, during conference season, I spoke with many advisors who had at least one client move to cash because they were convinced that Trump would win the presidency. They were right, but it was a very wrong decision.
The Cost of Guessing

In this case, let’s say an investor sold the S&P 500 on October 31st and moved to cash. As of January 31st, that investor missed out on roughly a 6% increase (dividends included). The real problem isn’t the significant underperformance – it’s the question of when to get back in. These investors guessed correctly on the election outcome (or for the overconfident ones, they “knew” it), yet they got it wrong with respect to market reaction (the overconfident investors will blame all the other “irrational investors”).

So do these investors (actually they have become speculators) just dive back in now? Do they wait for a pullback? How much of a pullback? What if that size of a pullback never comes? How much higher does the market need to go before they become investors again? I know a few investors who were very proud of their ability to sense danger and sell out of the markets before the financial crisis, but never got back in. When you start speculating on market outcomes, you need to be right twice.

The great tragedy for investors/speculators that choose to try to guess or outsmart the market is that their time and energy is devoted to a highly unpredictable scheme. They are no longer focused on their goals and values; instead their daily mood becomes highly correlated to whether the market moved in their favor that day. A truly unfortunate way to live life.
If Only We Could Learn From the Past

We may not know what the market will do going forward, but we certainly have a good idea that many investors will choose to become speculators. Perhaps they are seeking the rush that comes from winning and losing, as if they were at a casino. The difference is, for many investors, this isn’t discretionary money. This is their livelihood. Dalbar, Inc. has demonstrated time and time again that investors significantly underperform market indexes because they simply can’t stick to a strategy.

So for investors who like the emotion of investing, and guessing things “right” – I hope you enjoy. It may feed your ego when you are right, but it’s a costly endeavor. For everyone else, the excitement of winning and beating the uncertain is natural and alluring. If you are going to feed that urge, just don’t do it with your nest egg. Those activities are best left at the casinos.