When It Comes to Investing in the Stock Market, Timing Is Everything
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The stock market is at an all-time high! Must be a great time to invest, right?
Uh, no. You should've been throwing all your money into the stock market in the summer of 2009, just after it bottomed out, back when the first part of the investing cliché "buy low, sell high" was in play.
Not surprisingly, I'm seeing and hearing reports of supposedly smart people (doctors and lawyers, ferchrissake) doing the opposite. They sat on the sidelines for the last four years and only now are jumping back into the market. Wall Street has a word for these people: suckers.
Once again, market fluctuations are messing with average investors' minds.
They panic and sell when prices drop, then fall victim to what Alan Greenspan in 1996 called "irrational exuberance" and buy when prices soar. That's a sure way to lose money.
Research from financial services firm Dalbar can tell us how much. During the 20-year period ending in 2012, the S&P 500 index returned an annual average of 8.21 percent, but the average person who invested in stock-market mutual funds earned only 4.25 percent.
Some of this loss was due to fees and expenses, as well as poor choices by fund managers. But, according to Dalbar, about half of this "disease of investor underperformance" can be attributed to investors' psychological factors, including misplaced optimism and loss aversion.
The lesson here is simple: To make money in the market, remove the human element from the equation. Here's how.
Don't follow. If you do what everyone else is doing, you're likely to get burned. That's how folks went bust during the housing bubble, and it's how they lost big bucks during the market collapse in 2008. Yet we do it anyway. It's in our nature. Remember your big hair in the '80s? You were following the herd.
When it comes to investing, consider the advice of Warren Buffett: "Be fearful when others are greedy, and be greedy when others are fearful."
Stick to your plan. Socking money away regularly and automatically does pay off in the long run, even if the market goes through the dramatic swings we've seen over the last 10 years. Keep in mind that the crash in 2008 didn't wipe out those looking to retire; it simply delayed their retirement. With the market now reaching new highs, people can stop working and have a chance at a richer lifestyle than they would've enjoyed had they cashed out five years ago.
Keep costs low. In his book Your Money and Your Brain, Jason Zweig summarizes decades of research into one investment truth: "The single most critical factor in the future performance of a mutual fund is that small, relatively static number: its fees and expenses."
To reduce costs (and to keep things simple), stick to index funds, low-cost mutual funds designed to track the broader movement of the stock market.
Ignore financial news. In Why Smart People Make Big Money Mistakes, authors Gary Belsky and Thomas Gilovich cite a Harvard study of investment habits. The findings? "Investors who received no news performed better than those who received a constant stream of information, good or bad."
If this reads like Investing 101, well, it is. But it bears repeating when you consider this reality check: If you had done nothing with your portfolio after the crash in 2008 except make regular contributions to it, you'd be rewarded with a net worth that's well above where it was before the crash. Funny how doing nothing can make you look brilliant.