According to Thomson Reuters Lipper, investors pulled over $60 billion from mutual funds in January, the worst month of outflows we’ve seen in years. Mutual fund outflows are one way to get an idea of what retail investors are doing. Whether they are self-directing or calling up their advisors and demanding their plan be thrown out the window, mutual fund outflows suggest that retail investors are not optimistic about the market.
How did their timing turn out? Retail clients pulled out just in time to see the market run up about 8.5% from January lows until the end of the second week of March. That’s even when we consider the fact that the market plunged even lower in February, when incidentally, billions continued to be pulled out of mutual funds.
This information is not intended to beat up on retail investors, but to introduce investor psychology as being a critical factor in long-term success. If someone with a short-term time horizon wanted to raise cash, the time to have done it would’ve been Q4 of 2015, not January-February. But the market is a machine designed to prey on our emotions. Our emotions, unfortunately, always tend to be late.
It’s hard to sell when things feel better, and hard to buy or hold when things feel worse. By the time if feels good, it’s too late to capitalize. By the time you can’t stand it any longer and pull out, opportunities are just starting to pop up again. A lot of this can probably be blamed on the fact that most investors spend too much time watching the financial news media. It is puzzling to me that people attempt to get trade ideas from people who aren’t paid to help you succeed, but paid to make sure you stay tuned so they can keep getting their ad revenue. Their interests aren’t in line with yours, thus they should not be considered as a good source of advice.
No matter what your strategy for navigating the market, discipline is usually the component that is most likely to fail. Discipline fails because of emotions that lead to impatience. Changing strategies because a market has already fallen is unwise. Instead, a strategy should be entered into before turmoil begins. Further, you should enter that strategy knowing how it will react in a tumultuous environment and whether such a reaction would affect your ability to meet a long-term goal.
Year to date, the market has almost broken even; it has punished investors who panicked, didn’t know their limitations as a market forecaster, or abandoned their long-term plans. The market’s goal is to make as many people look silly as it can at any given time.
How can you be a better investor? Here’s one tip: watch out for confirmation bias. This is one of the biggest causes for bad investment decisions I see. Confirmation bias refers to our tendency to search for information that confirms what we already believe, or to interpret information we have in such a way as to confirm our preconceptions. In other words, we think we are basing a decision on facts, but in reality we are just looking for “facts” to make us feel good about an emotional decision.
Thus, if you already wanted to buy, you’ll have a keen ear for people telling you to buy. You’ll find arguments for why you should buy stickier in your mind, and you’ll find them more convincing. On the other hand, if your emotions say sell, you’ll overweigh any information you hear that would agree with that course of action. Nobody wants to make an emotional decision, but confirmation bias is our brain’s way of tricking us into thinking we’ve been truly objective and not emotional!
In conclusion, get a plan. Know what to expect from it. Stick to it. If things need to be changed, change them because the destination has changed, not because the road you just traveled was uncomfortable.
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