How Investors Rationalize Their Fears… and Lose Money
- The recent coronavirus crash led many investors to panic and pull their money out of the market.
- But, as Alexander Green explains today, this is never a good idea. Market timing simply does not work.
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Although there has been plenty of volatility along the way, the market has taken a tremendous bounce off the March 23 low.
There are five primary reasons:
- After the pandemic caused the fastest bear market in history, stocks – as well as many corporate and municipal bonds – became ridiculously cheap. (That is always a self-correcting problem.)
- The Federal Reserve lowered interest rates to zero again, offered essentially unlimited liquidity to financial markets and made unprecedented asset purchases, including corporate bonds.
- Congress passed – and President Donald Trump signed into law – massive fiscal stimulus worth trillions of dollars.
- Moderna (Nasdaq: MRNA) and several competing biotechnology companies are closing in on an effective coronavirus vaccine.
- There is widespread recognition that the worst of the government-imposed economic lockdown is behind us.
Despite this good news, a few readers in the comments section sound downright cranky. I think I know why.
As my friend Mark Skousen likes to say, “No one is more bearish than a sold-out bull.”
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The folks who sell in a panic always regret it.
Any investor can make an emotional mistake, getting too optimistic – some would say “greedy” – when times are good or becoming overly pessimistic when times are bad.
Yet during my 16 years in the money management business, I discovered that the same folks who panicked in one market sell-off would invariably panic in the next.
And the one after that.
Clients who bailed out after the crash in October 1987 capitulated in the market downturn of 1990, the “tech wreck” of the mid-1990s, and the ferocious bear market from March 2000 to October 2002.
Some people are just hardwired to react emotionally. They can’t help it.
Oftentimes, they don’t even realize that they have rationalized their fears.
An excuse is a lie we tell others. A rationalization is a lie we tell ourselves.
Here are a few from The Rationalization Hall of Fame:
Everybody does it.
No one will ever know.
I’m not trying to win a popularity contest.
She’ll thank me later.
I’m only human.
It’s the thought that counts.
And my own personal favorite: Ice cream is an excellent source of calcium.
Psychologists call this the self-justification bias. We make decisions – or arrive at certain beliefs – for emotional reasons.
We then go to work cherry-picking data that supports our view while systematically ignoring or filtering out contradictory evidence.
Here’s how this plays out in financial markets…
- Stocks take a sudden, unexpected drop. (As they did in the first quarter when it became clear that the coronavirus could not be contained.)
- The investor looks at his brokerage accounts and sees his hard-earned money going up in smoke – at least temporarily.
- Feeling fearful, he imagines things will only get worse. (The national media is an accessory here, pouring on the gloom and doom and sensationalizing the situation.)
- He decides that he will move to cash and get back in the market later, when things look better. (Like they always do at the bottom, right?)
- The market – a forward-looking indicator – rebounds before the improvement materializes.
This has happened to countless investors throughout history.
And they are always left in the same predicament…
They got hammered in the sell-off. Then they missed the rebound.
Already smarting, they realize that if they jump back in, there could be another sell-off. (Always a possibility.)
Or the market could continue rising and they will be left in cash earning essentially nothing. (Also a possibility.)
The higher the market goes, the starker the choice becomes, along with the potential consequences.
This is exactly why market timing is no part of The Oxford Club’s investment strategy.
I know it looks so easy when you glance at the market’s past performance.
You only had to get in somewhere down here… and then out somewhere up there… then back in again down here.
This is Fantasyland.
Peer into the future and all you will ever see is a blank slate.
If you’re ever tempted to play this game, just remember that there are only two types of market timers: those who don’t know what they’re doing… and those who don’t know they don’t know what they’re doing.
About Alexander Green
An expert on momentum investing, value investing and investing based on insider activity, Alex worked as an investment advisor, research analyst and portfolio manager on Wall Street for 16 years. He now runs the wildly successful Oxford Communiqué, ranked as one of the top investment newsletters by Hulbert Digest for more than a decade. He is also the author of four national best-sellers: The Gone Fishin’ Portfolio, The Secret of Shelter Island, Beyond Wealth and An Embarrassment of Riches. He shares his wisdom in his free daily e-letter, Liberty Through Wealth.