Not many people equate George Costanza from Seinfeld with smart decisions. However, sometimes the smartest people in the room are those that know their own limitations. Investors could benefit from this advice.
We can all learn from the information tracked and available regarding how investors move in and out of the equity markets. If we could take out our emotions and use this information as a guide, investors would have better results.
Today’s Market
Today, the S&P 500 is up about 17% (Morningstar) for 2012. International stocks, as measured by the MSCI EAFE Index, are about 13% (Morningstar). So far, 2012 is shaping up to be another positive year for the market. This makes four years in a row for the S&P 500 and three out of four for the international stock market.
So investors are happy, right? Probably not.
Investors sold a significant amount of stocks in 2008 during the financial crisis and have continued to sell stocks ever since. According to data from the Investment Company Institute and ING U.S. Investment Management, participants in 401(k) plans did the following:
- Sold $137 billion of equities from 2009 through 2011. ($90 billion of this amount was sold in 2011.)
- Bought $171 billion of bonds.
While this data is for only a portion of the overall investors, it is consistent with other sources of data that paint the same picture. Investors sold stocks when they would have made more money by purchasing stocks or just by holding them.
We all know that the best investment advice is “buy low and sell high”. Unfortunately, investors tend to do the opposite. The typical investor sells to avoid further losses after stocks have fallen and buys to get back in the market after stocks have risen.
So, what should investors do? They should stick to the George Costanza theory. In a classic Seinfeld episode called “The Opposite”, George finally figures out that all of his decisions have been wrong: “It became very clear to me sitting out there today, that every decision I've ever made, in my entire life, has been wrong. My life is the opposite of everything I want it to be. Every instinct I have … be it something to wear, something to eat ... It's all been wrong.” Jerry concludes that “if every instinct you have is wrong, then the opposite would have to be right.” So George starts to behave opposite of his instincts and his life starts turning around as he gets a job with the New York Yankees and moves out of his parents’ house.
Warren Buffett comes to a similar conclusion, but he phrases it in a more eloquent manner. He says, be fearful when others are greedy and be greedy when others are fearful (paraphrase).
What Should Investors Do Today?
How about today? What should a rational investor be doing today? Pay attention to what the mass of individual investors is doing. Historical data would indicate that when these investors are beginning to buy equities in large amounts, they are getting frustrated with missing the appreciation of the equity markets and are getting back in. This may be the typical sign of greed that Warren Buffet was referring to. Therefore, based on Mr. Buffet’s advice, you should be fearful and consider selling some of your equity positions. While this may be contrary to our human instincts to go with the herd, just like George Costanza, if investors could learn to do the opposite of their instincts, most of them would benefit.
Summary
While it may be smart to watch the investing trends of individual investors as a group, it is smarter to focus on your own portfolio and your own long-term goals. Your investment portfolio needs to be invested to meet your long-term objectives. While it appears that the equity markets are priced reasonably and businesses continue to appear strong, you should only have exposure to the stock market to the extent it is appropriate for your overall long-term objectives.
This article was contributed by Bill Wendling, CFA, an Investment Manager at Bedel Financial Consulting, Inc.