You’re familiar with herd mentality: you know, that tendency to adopt whatever viewpoint is most popular among those around you. What you may not know is that taking that approach to investing is a wolf in sheep’s clothing. At some point, it’s going to bite you in the rear. Here’s why.
Taking advice from those unqualified to give it never goes well.
Would you take medical advice from your uncle Charlie whose only experience was that he “once stitched his own toe using a fishhook?”
How about taking legal advice from cousin Becky, who’s been sued successfully 22 times?
Not biting? I didn’t think so. So why, then, would you takemoney and investing advice from someone who doesn’t have any?
Why do so many people listen to a “trusted” friend or family member about money matters, when that person isn’t any better off financially than they are? If you want to be above average in anything, you need to learn from and associate with others who are also above average. This is just as true when it comes to personal finance as it is anywhere else.
Panicking when others are panicking is a great way to lock in losses.
Part of the reason why the COVID financial market crash has been so severe is that, as people started seeing the markets drop, they began panicking and selling off their investments, adding more fuel to the fire and making things drop even further.
If we know anything about the financial markets from history, however, it’s that they almost always recover after a downturn. Leave your money where it is, and you’ll get it back. Sell when things are down, and you’ve just shot your financial future in the foot.
In the wake of the 2008 financial crisis, investors who left their money in the TSX would have been rewarded with more than a 30% increase for the year of 2009. But those who panicked and sold out into something “safe” like GICs? They saw none of those gains.
Investing is supposed to be done without emotion. So if everyone around you is selling because they’re “scared,” that should set off warning bells and tell you that it’s probably time to hold tight.
There’s an old story in the world of investing about a woman who invested $10,000 in her youth. Some 30 years later there was a horrible market crash, and the woman feared for the safety of her investment. When she called her advisor, her fears were confirmed. He said “I’m sorry ma’am, but your investments have fallen to $134,000.”
The point of that story is that, if you have a weak stomach for market swings but want to invest for retirement, you shouldn’t be paying attention to what the markets are doing in the short term. Your money will weather the storm, as long as you don’t sabotage it along the way by panic-selling.
So is buying when everyone else is buying.
On the flip side, when the going is good, you’ll hear from all sorts of people that are only too happy to talk about how much money they’ve been making in the markets. Remember this though: if everyone is buying, sooner or later there’s going to be no one left to buy from. When the supply of stocks runs short, people will start selling, and the price will go back down again.
What that means is that, when your buddy Joe and everyone else around you is ecstatic at how much the market has increased, it might just be a sign that it’s going to turn around sooner rather than later. If you buy when everyone else is buying, you might be buying at literally the most expensive time possible.
What’s better: buying a pair of shoes for $500, or buying that same pair for $200? Anyone with half a brain would choose the latter. So why do people throw that logic out the door when it comes to investing? The time to buy is when markets are cheap – in other words, when everyone else is selling.
We’re last on the totem pole when it comes to “hot tips.”
“Sure, that’s true for most people,” you might be sitting there saying to your screen, “but I’m not most people. I invest in stocks, and I have friends who do the same and give me all kinds of great stock tips.”
Alright, I’m a little guilty of this one sometimes too, particularly through this downturn. But let me ask you something: if you, an individual investor, know about this “hot tip,” do you not think that maybe, just maybe, many others do as well?
How about investment advisors who are paid to provide advice to their clients? How about mutual fund companies trying to beat the market? How about pension managers who manage tens of billions of dollars at a time? These guys have sophisticated financial analysis tools that you and I can only dream of; our chances of discovering something they don’t already know are zero.
What this means for you and I is that, by the time news of that “hot tip” reaches our ears, it’s already been factored into the price of whatever it is you’re buying. If a stock was discovered to be cheap, it was already bought up to its fair market value by the time you get there. In other words, your hot tip just ran cold.
Wrapping it Up
Warren Buffet famously said that one of the secrets to investing successfully is to “be fearful when others are greedy, and greedy when others are fearful.” In other words, take a contrarian approach to investing. If everyone else is freaking out because the market dropped, don’t listen to them and follow suit; go and invest while the market is on fire sale. When everyone is bragging about how much money they’ve made, you should be thinking about whether it makes sense to sell in preparation for a downturn.
Or, you could just ignore all of that and put an equal amount of money in each and every month. That way, you’ll be buying high, buying low, and everything in between, and you won’t have to worry about when to buy or sell.
In either case, remember this: being a sheep when it comes to investing is generally a recipe for low returns and future trouble. Remember: it’s not a great idea to take money advice from people around you who are no better off than you.
Now, if you want to invest but you’re not sure what to invest your money in, an index mutual fund can be a great place to start. I’ll write more about what those are in a later post.
