My good friend Dennis, a Seattle-based TV studio producer, pulled me aside Monday after I'd wrapped up Monday's appearance on FOX Business Network's "Varney & Co." to voice a sentiment I hear a lot these days:
…I'm almost 60 and scared to death by what's happening today – terrorists, a looming rate hike, slowing earnings, global growth cratering.
He rattled off half a dozen items bugging him, counting each on his fingers. Then he leaned in and quietly said…
…it makes me want to sell it all.
If you're like Dennis, you're not alone.
Investors pulled almost $40 billion from the stock market last quarter alone, according to Morningstar. That's nearly 50% of everything taken out for all of 2015.
But here's the thing… no matter how grim the global situation is or even becomes, indiscriminately selling is exactly what you don't want to do.
It's one of the worst possible decisions any investor can make and, ultimately, one that will cost investors billions in lost profits.
Today we're going to talk about why and, because this is not a simple subject, I'm going to prove it to you, too.
Roller Coaster Stock Markets DON'T Have to Mean Roller Coaster Returns
We've talked many times about the importance of buying low and selling high. It's the path to higher returns.
So why is it that so many investors get it wrong?
The answer comes down to a phenomenon known as "recency bias." That's what they call it when investors make decisions based on what they see in the rear-view mirror. If the markets are going up, they buy. If they're going down, they sell.
Simply put, they base their expectations for what's next on what just happened. That's like trying to bet which t-shirt a three-year-old will wear tomorrow, and about as successful.
In fact, there's very little correlation between past stock market returns and actual future returns.
Moreover, YiLi Chien, a senior economist for the St. Louis Fed, studied equity markets from 1984 to 2012 and found that the correlation between past market behavior is almost perfectly negative over time.
That jives with the DALBAR data we've already covered here in Total Wealth showing that individual investors who try to time the markets wind up damning themselves to terrible returns by falling far behind over time – nearly 200% behind, in fact.
People tell me frequently that they don't care. They want to sell anyway because they can afford to wait.
Respectfully, no they can't.
Chien's study also shows individual investors trying to second-guess the markets may fall behind by nearly 40% in only seven years. Extrapolate that out 20 years and you're talking about potentially missing out on 300% to 500% or more in cumulative gains.
Again, the flight to safety is a powerful incentive. I get it, but the stock market has a long-term upward bias that we've talked about many times. Sure, it may have some short-term speed bumps, but over time the constantly increasing amount of capital chasing fewer quality stocks ensures higher prices. Over a day, a week, a year… it really doesn't matter much.
About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.