This is a guest post from a friend of mine, who owns the sites Young and Thrifty and My University Money. It’s an interesting look at investing — and why you might not be built for the stock market.
Isn’t a personal finance and investing site supposed to give me like a magical guide to picking stocks or something? Isn’t it just buy low, sell high and all that good stuff? I watched Jim Cramer last night and he told me exactly what to do.
If you have ever said or thought any of these things, don’t worry, you’re not alone, and there is help. These are some of the things that people tell themselves as they attempt to get into the stock market and pick stocks. They convince themselves that they can put their money to work. After all, they watched CBNC last month and can tell you what a Price-to-Earnings ratio is, so they are ready for the big time. There is only one problem. Humans as a species are genetically hardwired to fail at picking stocks.
You see picking stocks involves taking risks, and trusting your brain over your instincts. This is easy to say when you’re dealing with a hypothetical portfolio or when you’re investing in a decade-long bull market. It gets much more difficult when you see 10% of your life’s savings evaporate overnight thanks to some numbers on a little ticker at the bottom of your computer or TV screen. Humans have evolved to avoid risk. It’s really not that surprising when you consider that we are only a few thousand years removed from avoiding predators who are bigger, stronger, faster, and more hardy than we are, as well as never knowing with any certainty where our next meal was coming
I read once that Warren Buffett said in an interview that he was very fortunate to be born in the time period that he was. When the interviewer asked him why he felt that way, he responded that his only real talent (as judged by himself) was in allocating capital (few would argue he has a talent for this). If this had been his sole talent 5,000 years ago, he would have likely perished very quickly, or lead a subsistence lifestyle. Instead, he gets to live his life in the lap of luxury. Interesting perspective – Buffett knows that he is an exception to the way most of us operate. He and his partner Charlie Munger, have stated that they know that at any given time they could lose up to 40% of their net worth (in fact they have before). They are prepared for that, most of us aren’t.
Panic and Adrenaline Used To Be So Useful…
Most humans have strong instincts (that would have guided us just fine throughout history) that tell them to get onboard with something when there is some consensus, and a general feeling that it has momentum. An example of this would be when the talking heads on TV yell about how “hot “ a stock is, or when your buddy at the water cooler tells you how his cousin’s investment advisor really believes that this stock is about to blow up. Then we panic when we feel loss start to set in. The long-term outlook begins to be clouded by the haze of short-term pain as we watch the red numbers climb higher and higher, and our dream retirement seems further and further off. Our instincts tell us to sell off before the worst case scenario occurs and our investment capital disappears entirely, and we step off the rollercoaster only to look for the “next big thing” and hop back on again.
If you don’t believe my anecdotal physco-babble, then consider this: a recent DALBAR study revealed that over the last 20 years, the stock market has returned an average of 9.1% (yes even with those crashes everyone talks about). Go ahead and take a guess at what returns the average investor received during that time… no seriously, guess before reading on… the answer is 3.8%… no, that isn’t a typo, it’s 3.8%. So how did the average investor realize well under half of the average gains in the overall market? It’s simple, they merely followed their instincts.
Who Needs Facts? Stories Are So Much Cooler
The media doesn’t help us out much on our quest to bend our will to our intelligence. Instead they trot out expert after expert that is willing to yell, or state quite convincingly whatever argument they are paid to represent, just as long as it is extreme and entertaining. Ever wonder why investing shows, or business parts of the news always seem to be predicting a huge upsurge or the next crash? It’s because news is in the same business as entertainment is, and that is the business of getting eyeballs in front of advertisers’ messages; therefore, the line between news and entertainment
often gets blurred in the name of attracting as many viewers as possible.
What’s more interesting: the idea that markets will likely muddle through and go through ups and downs on its way to averaging 9-10% over the next couple of decades, or that the next 10 years will either make you a millionaire and/or bankrupt you?
Are You The Next Warren Buffett?
It’s absolutely amazing how many truly smart people out there believe they can beat the market and do better than the stock pickers that came before them. When a vast majority of studies out there claim that most professional money managers that run mutual funds can’t even beat the market, why should we even try? Instead, if we simply subscribe to basic passive investing principles, we can realize the great returns of the equities asset class without the constant headache of striving against the very instincts that kept us alive 5,000 years ago. I wonder if there was a stock guru 5,000 years ago that thought to himself, “Man, if only there was a mechanism where I could be rewarded for my ability to allocate capital right now,” as he ran away from the lion he didn’t see coming?