It’s a fancy title with a simple definition. At its core, contrarian investing is all about doing the opposite of the prevailing market opinion. In other words, when the market zigs, the contrarian investor zags. It can be a market-beating formula, and it’s used by some of the biggest names in the investing world, including Warren Buffet. But how do you actually put the strategy into practice?

Look for moments where sentiment doesn’t match reality.

When sentiment is particularly positive (like during the tech bubble of the late 90s) or negative (like during the first month of this pandemic), these are good signals that it might be a good time to take a contrarian approach. In the 90s, that means selling off all those tech stocks when everyone else was pouring their life savings in. More recently at the start of the pandemic, that meant buying things like banks and airlines when all of the newspaper headlines talked about how they were all doomed businesses.

Any time the market overreacts one way or another is a good chance to take a contrarian approach. For example, everyone is piling into Bitcoin with no rationale as to why, other than because the price is going up. Great! It’s probably a good time to stay the hell away from bitcoin as a contrarian investor.

The key is in the mismatch.

It’s important to know that, sometimes, an investment moves a certain way for a reason. Just because an investment moves strongly in a certain direction, doesn’t mean it’s a good contrarian bet. For example, all kinds of silly investors have been bidding up GameStop as a meme stock. It’s gone up a ton, not because it’s got a strong foundation as a business, but because people just keep bidding it up, hoping they can sell to someone even dumber later on.

When that stock comes crashing down to earth again, and everyone is saying how bad of an investment it is, that’s because it is. That is NOT a good time to be a contrarian investor. In that case, sentiment became re-aligned with reality, not the other way around. It’s super-important to know the difference.

Contrarian investing is only a good move when you do it because other people are overestimating how good or bad an investment is. When they’re selling because the investment sucks, being contrarian is just a good way to lose money.

Good contrarian investing takes a bit of work.

In order to know whether an investment is good or bad, you need to know at least the basics of analyzing an investment. I’m not going to cover that off today, but this great article from NerdWallet will give you a start.

You also need to be tuned into the market with some degree of regularity, or else you risk missing out on great opportunities. This means that, if investing isn’t something you enjoy, you probably are better off just focusing on putting away money in regular intervals – something known as dollar cost averaging – than spending a lot of time doing something you’re going to hate.

To be successful with a contrarian approach also takes patience. You’ll need to get comfy with the fact that your investment choices may underperform the market for a long period of time before you finally get paid off. This might mean listening to uncle Larry brag about his big gains at family parties for months (or even years) before you can finally silence him with your own success stories.

Contrarian investing can be done with index funds.

That’s right, contrarian investing works with some of my all-time favourite investments: index funds. In fact, because index funds mirror the sentiment of an entire market or segment, they’re arguably one of the very best places to do contrarian investing.

Here’s how you do it:

• Start with a mix of stock indexes and bond indexes. My preferred split is about 70/30 in favour of stocks.
• When the stock index hits a high-water point, sell some of your stock index off, and invest that money into your bond index, which probably isn’t up as much.
• When the stock index hits a historical low point, sell off some of your bond index funds and buy more of the stock index.
• Rinse and repeat once a month, quarter, or year – whatever you like.

By taking this approach, you’re basically always buying low and selling high, and you can actually beat the average return of the stock index you’re buying over the long term by taking this approach. I’ve done this with the TSX, and over the last 8 years have beaten the market return by about 3% per year, on average.

Wrapping it Up

Contrarian investing can be a lucrative strategy, but it isn’t for everyone. If you’re impatient, prone to giving in to the messages you hear around you on a daily basis, or can’t handle a bit of extra risk, then contrarian investing isn’t for you. But if you’re willing to put a bit of work in, the rewards of a contrarian investing strategy can be well worth it in the long run, potentially even shaving years off your working career.