You Invest Poorly for the Same Reason You Spend Too Much

Beyond Buy-and-Hold #7

By Rob Bennett


Say that there was a Guru who truly knew everything there is know about investing and that he was kind enough to start a blog and tell you the answers. And say that you were smart enough to appreciate how smart this fellow was and to read him every day. Would this make you an effective investor?

It would help. But by itself it would not make you an effective investor.

To explain why, I need to ask you another question.

When you see a television commercial in the ?Got Milk?? series, does it make you buy more milk?

Most people say ?no.? They point out that the phrase ?Got Milk?? doesn?t contain any intellectual content. How could that phrase possibly persuade anyone to buy milk?

Well, it does.

If it didn?t, the people who make a living selling us milk wouldn?t spend millions of dollars insuring that we all see those commercials. If you aren?t affected by the ?Got Milk? commercials, you surely are affected by the ones with sexy women standing by sports cars or by the ones in which all the people drinking Mountain Dew have big sunny smiles on their faces.

The unspoken power of repetition

It?s not because you are dumb that advertising affects you. It is because you are human. Advertisers rely on research showing what influences us humans to develop their pitches. The two biggies are: (1) appeal to the emotions rather than logic; and (2) employ lots of repetition.

The smart thing is not to deny the effect. The smart thing is to take the effect into consideration when making money decisions.

Lots of people don?t save enough. Are they dumb? Do they lack willpower?

No! If they were dumb or lacked willpower, they wouldn?t be able to hold down good jobs and earn all that money they?re not saving.

Most decisions to spend or to save are rooted not in the intellect but in the emotions. The people who don?t save don?t even know why they don?t save. If you ask them why, they will just make silly excuses.

They don?t save because they feel that they should be spending. And they feel that they should spend because television commercials have caused them to feel that way.

I am not opposed to advertising. It is part of modern life. My take is that we need to stop pretending that all of our choices are the product of intellectual beliefs and accept that advertising puts thoughts in our heads that cause us to take actions we otherwise would not take. We cannot defend ourselves against advertising without first acknowledging its power.

Now — on to investing.

Does market timing work?

It always works (so long as it is of the long-term variety and not the short-term variety). There is not one exception in the entire historical record. It is not even possible for the rational human mind to imagine an alternate universe in which long-term market timing would not work.

If you?re not engaged in long-term market timing, you?re staying at the same stock allocation at all times. That means that you are putting as much money into stocks when they are insanely overpriced as you are when they are low-priced or moderately priced. Common sense tells us all that that is not a good idea.

But millions today believe with their hearts, minds and souls that market timing does not work or that it is not necessary to engage in market timing. For the same reason why they buy more milk when they are exposed hundreds of times to ?Got Milk?? television commercials.

The Stock-Selling Industry makes lots of money when we buy stocks and not so much when we invest in things other than stocks. It?s not hard to understand why the industry would want us to believe that market timing doesn?t work. But why do we fall for it?

Advertising DOES affect our behavior

We?re human. We are affected by advertising. The people who develop marketing campaigns know what they are doing. They appeal to the emotions and they repeat their message thousands of times. That?s what works (for them, not for us).

Long-term market timing is what works for us. Market timing is required for long-term investing success. But most of us invest in the way that the industry marketing campaigns tell us to invest. This needs to change. We need to start talking about this sort of thing more frankly than we ever have before.

Even if a Guru told you all there is to know about stock investing, you would still be pulled in by the marketing campaigns. The Guru could teach you the logic used by successful investors. But emotions trump logic every time. To protect yourself from the effects of the marketing campaigns, you need to become aware of how they affect you and to develop tools to counter their effect.

People fight the marketing campaigns encouraging them to overspend by forming communities on the internet where they help support each other in their new approach to money management. We need to begin doing this sort of thing in the investing realm too.

Hey! Maybe we could form a 12-step recovery program for recovering Buy-and-Holders!That would be a good start! We?ve got to get over our emotional addiction to stocks before we can hope to begin investing in them successfully.

Rob Bennett views Buy-and-Hold Investing as a well-intentioned mistake. His bio is here.

( Photo courtesy of AMagill )

9 Responses to You Invest Poorly for the Same Reason You Spend Too Much

  1. I think that another important reason why people don’t believe market timing works is because day-traders and the like are used as the “poster children” for market timing. So when most people think of market timing, they think about guessing, gambling, and speculation. We have images of traders losing their life savings and jumping off of buildings!

    I’ve only heard of long-term market timing within the last 2 years, and I studied investing pretty regularly (both in school and on my own). So I think people need to learn that you can time the market based on valuations and not just on a tip from a guy who knows a guy. Then maybe they can combat the repetition and ads!

    Good post!

  2. Khaleef – Thanks for weighing in. I think you’re right on the money with what you’re saying. Mention market timing and people automatically think about day trading. Its conditioning from the media just as Rob wrote in the post.

    If you’re a long term invester, market timing is a must. You want to buy in at the best times, which is when valuations are the most favorable.

    An excellent example was March 2009. Everyone was getting out, but the few brave souls who saw the opportunity for what it was, bought in and they’re way ahead. Most people need a lot of validation before investing, so they wait until a bull market has run a couple of years or a few thousand points, then jump in with both feet.

  3. The average investor listens to the media and is fearful when others are fearful and greedy when others are greedy. The very opposite of what Warren Buffet would suggest – and we all know his track record!

  4. when most people think of market timing, they think about guessing, gambling, and speculation.

    Yes, Khaleef. I also say that you have put your finger on it. And there are two very encouraging conclusions that can be drawn from this insight.

    One, the people who developed Buy-and-Hold generated some insights of huge importance. They advanced the ball by warning us of the dangers of short-term timing. They did this by making use of data and academic research. We should not lose sight of this. Data and academic research can be powerful tools for learning more about how to invest effectively.

    Two, middle-class people are ready for a more realistic approach to investing. I have heard lots of people say “oh, it’s just human nature to fall for Get Rich Quick approaches.” Yes and no. It is indeed a weakness of human nature to fall for Get Rich Quick. But we must remember that Buy-and-Hold has never been marketed as a Get RIch Quick approach. Quite the opposite is so. It has been marketed as ANTI-GRQ. And it is amazingly popular! That shows that people WANT to overcome their attraction to GRQ. We just need to get about the business of helping them learn how to do so.

    We all need to develop an historical perspective re all this. The wonderful news is that the two most important insights in investing history happened both to become known to us over the past 50 years. The two are: (1) short-term timing never works; and (2) long-term timing always works and is in fact REQUIRED for long-term success. We are blessed to know both of these things today.

    But look at what has happened! We learned the first insight first and then closed our mind to the second one (because of a confused belief that the two things cannot both be so) And the first one does us no good unless we tap into the wisdom of the second one as well. This is all a huge tragedy! We just need to persuade the Buy-and-Holders to calm down a bit and acknowledge that they did not get it all right in their first draft version of research-based investing, and then we are all on our way.

    The Buy-and-Holders did great but flawed work. So let’s make the necessary changes and then all move forward into a wonderful and enriching future together. Not one person alive benefits from not knowing how to invest effectively. So there should not be one person opposed to the idea of tapping into the benefits of BOTH huge insights. Humans!

    We’ll get there. But, boy, we sure have gone out of our way to make this an unnecessarily rocky ride!

    Rob

  5. Back in March 2009, I didn’t jump in, but I did stick my big toe in to test the waters. I wish now that I hadn’t been so fearful. I purchased a few stocks that have done well since. What I do not understand is how to tell when the market has swung too far to the overvaluation side of the equation. I’m wondering if we are in a time of overvaluation now and if it isn’t a good time to sell stock that have given a good gain. I only buy individual stocks and only in my Roth IRA.

  6. What I do not understand is how to tell when the market has swung too far to the overvaluation side of the equation.

    I provide a tool at my website to help people do this, Normal. It is a calculator called “The Stock-Return Predictor”:

    http://www.passionsaving.com/stock-valuation.html

    My recollection is that the P/E10 level in March 2009 was 12. Enter “12” into the calculator and take a look at how the numbers change from what they are for stock purchases made today.

    Do you see? Those who purchased a broad index fund in March 2009 are likely going to have an annualized 10-year return of 8 percent real! That’s the edge you get by being willing to look at the price at which stocks are selling before putting money in the table. That 8 percent real number is far better than what is available today and far better than what was available at any time from January 1996 through September 2008.

    Unfortunately, this tool only works for those investing in broad index funds. There are too many factors that apply with individual stocks to make statistically significant return predictions possible.

    The benefit of buying individual stocks is that, if you choose effectively, you will do better than indexers. The downside is that there is no simple way to predict your long-term return. With individual stocks, only lots of research permits you to make effective predictions.

    It is indexing that makes stock return predictable. This is one of the great unsung benefits of indexing.

    Rob

  7. The very opposite of what Warren Buffet would suggest

    Yes, Buffett certainly understands the realities, Jason.

    My one criticism of Buffett is that he does not speak out more strongly in opposition to Buy-and-Hold. My view is that the market is a public resource, like the mountains or the oceans. We all suffer when bad investment advice causes an economic crisis. So I would like to see people like Buffett speaking out more strongly.

    He’s a great person to study for good guidance, however. If we combined the wisdom of Buffett’s approach with the simplicity of Bogle’s approach, we would all be in great shape, in my assessment.

    Rob

  8. I don’t know your feelings about Jim Cramer, but he preaches the same thing. “Buy and Homework.” Buy low, sell high but not often and panicky. I don’t follow all his stock picks and sometimes I disagree with his stock picks, but I agree with his philosophy of “Buy and Homework.” You have to keep an eye on your stock and know when to sell eventually.

  9. Thanks for stopping by and sharing your thoughts, Jermaine.

    I don’t follow Jim Cramer and know little about him. I have heard people criticize him severely but it’s possible that that’s just people finding fault with an approach they don’t personally follow out of defensiveness.

    There was a clip I saw of Cramer once where he asked (this is a paraphrase, not a quote) “who holds these Buy-and-Hold people accountable?” I liked that a lot. Not because I am out to “get” the Buy-and-Holders. I just come at things from a journalism perspective and I believe that the advocates of ALL strategies should be challenged. That way we all learn the weaknesses as well as the strengths of our ideas. I think that our biggest problem today is that Buy-and-Hold has been put beyond criticism. I know that Cramer is at least opposed to that.

    People criticize Cramer because he puts on a show. I have mixed feelings about that. I view investing as a serious thing; I think you need to be responsible. But I of course understand that, to be popular, you have to put on some sort of a show. The trick is figuring out how to put on a show without saying things that are going to hurt people.

    I tell jokes and quote song lyrics and things like that. I try to take a less stuffy approach to the subject. That’s my “show.” I’ve been criticized for that at times. I’ve been told that no one who quotes song lyrics could have anything useful to say about investing. Yuk! My view is just the opposite. I view pretension as a bad sign, a sign that you have something to hide. So, to the extent that Cramer avoids pretension, I think that’s good.

    The other criticism of him is that he advocates picking individual stocks. I think it is hard to pick stocks effectively. So I see some merit in this criticism. I certainly don’t think that anyone should be investing in a stock solely because of what someone said on a television program. But it might be that Cramer gets some people interested in a company and then they do their own research and end up picking a good stock. So I don’t view even this aspect of his work as being all bad. I hope he warns people not to go just by what he says. That would be the right way to play it.

    Rob

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