How to Lose Money with the Stock Market at All-Time Highs

“When things are going well and prices are high, investors rush to buy, forgetting all prudence. Then when there’s chaos all around and assets are on the bargain counter, they lose all willingness to bear risk and rush to sell. And it will ever be so.” – Howard Marks

Stock markets around the globe continue to perform extraordinarily well. We enjoyed double digit returns in 2012 and again have double digit returns in 2013 and it’s only May. The stock market in Japan is up over 70% since November (not a misprint).

So this must mean that everyone is becoming wealthier and enjoying the gains, right? Unfortunately, this hasn’t been the case.

According to a Gallup survey stock ownership among U.S. adults is the lowest it’s been since 1998. The ownership level currently sits at 52%, down from a high of 65% in 2007. Here is the graph from Gallup:

There are a number of factors that could explain this trend. Unemployment has remained elevated (even though it is falling), more baby boomers are retiring (thus switching to bonds) and investors have de-risked after two huge stock market sell-offs.

These factors do come into play, but another reason is that investors are letting their emotions dictate their investment choices. Fear and greed are powerful emotions. They can cause us to make irrational decisions like selling at the bottom and buying at the top.

According to the Investment Company Institute (ICI), while stocks were on their way to more than doubling in value from 2009 to 2012, investors pulled out over $360 billion from their stock mutual funds.

During that same time frame investors added over $260 billion per year to bond funds.

Of course now that stocks have actually shown good returns for a few years in a row, investors have decided to reverse this trend and stock mutual funds have seen inflows of over $60 billion in the first quarter of this year alone.

I don’t bother to make predictions about future stock market returns, but if I had to venture a guess, I would say that those that missed all of the gains we have seen in the past four years that are now piling into the stock market are going to be disappointed.

My hope would be that those who cashed out at the bottom and moved their investments to bonds would reassess their risk profile to make sure they have the correct asset allocation.

Stocks can help you pick up longer-term growth but if you can’t handle the wild swings in price and continue to make emotionally charged decisions with your stock investments then maybe you shouldn’t invest in them in the first place.

Unfortunately, there are plenty of investors who got scared when the market sold off in 2008 and bailed out close to the bottom of the market. They probably told themselves that they would wait until things got better to get back into stocks. Now that the economy is slowly improving and stocks have performed well they are telling themselves it’s all clear and time to invest again.

This strategy is a great way to lose money. Stay with it long enough and you will be broke in no time.

A better option is to come up with a disciplined investment plan and stick to it. Automate good behavior so you don’t allow emotions to come into the equation. Figure out your ability and willingness to take risk and go from there.

As Carl Richard pointed out in his Bucks Blog column last week, inaction can actually be a key attribute to investment success. Here is his take:

Everyone else is moving, trading, talking. Why not us? It’s what investing is all about, right? Wrong.

That is called entertainment. If you want a term to justify it, you can call it trading. But the evidence is clear that it doesn’t work. So this is one of those rare opportunities to improve your results by being lazy. Build a portfolio that matches your goals, and forget about it. Maybe for years.”

This may sound like a boring strategy, but investing doesn’t have to be exciting to help you accomplish your goals.

Sources:
Gallup
Investment Company Institute
In Soccer and Investing, Bias is Toward Action

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  1. Martin commented on May 25

    Great write up and excellent chart. IMO it indicates why the markets refused correcting and why we still may see a strong uptrend in the near future. In the past those investors who missed the train were jumping on on every little dip. And from the Gallup’s chart above it looks like the trend will continue for some time.

    • Ben commented on May 26

      Good point. I think that the biggest risk to investors who have sold out of the market and are sitting in cash is a complete melt-up in the market. I don’t make forcasts of short-terms moves in the markets but that is a possibility with the underlying pessimism in the market by some. Climbing the proverbial wall of worry is tough to handle for those who are sitting out right now. We could see a correction but it’s hard to predict when that’s going to happen and what the actual magnitude will be.

  2. May Links: Happy Memorial Day Edition! | Dividend Growth Stock Investing commented on May 29

    […] How to Lose Money with Stock Market at All Time High – This is a good article over at A Wealth of Common Sense discussing the fact that while markets are currently at all time highs that doesn’t necessarily mean everyone is making money.  It’s a good article discussing the irrationality of the average investor.  You need to be above average by developing a solid long term plan and sticking to it.  Don’t trade in and out of stocks based on fear and greed.  Stick to a long term plan and you will be the ones making the money! […]