If you have been awake for the past five years, your investing experience has probably been anything but smooth. Scary markets like the one that bottomed out in March 2009 often cause us to do crazy things. This craziness might be temporary, but it doesn’t take long to make what I call the big mistake: ditching your well-designed investing plan to either buy high or sell low.
The market of 2008-2009 was the scariest one I have lived through. A lot of us were so scared we went looking for alternatives to our disciplined investing strategy — and in hindsight, that was a terrible mistake.
Hindsight is the crucial word. If you bailed out of your investing plan in 2009, by now it is painfully obvious that was a bad idea. By almost any measure, the market has more than doubled since those dark days.
So let’s think about this behavior. We spend a lot of time designing a rational, long-term plan — presumably when we are thinking clearly. Then, when things get crazy, we scrap that plan and tell ourselves there is another way. We make a change that turns out to be a bad idea. Then we repeat that process every few years. It would be comical if it weren’t so painful.
Avoiding this kind of dysfunctional behavior is the crux of investing. The biggest risk investors face is getting scared out of their plans at exactly the wrong time.
Exciting markets cause us to do foolish things, too. Those mistakes look just as obvious in hindsight. Did anyone become a real estate investor in early 2007?
So how do we identify the big mistake before we make it?
The big mistake is usually part of telling ourselves one of a number of stories that are constructed to persuade us our long-term, rational plan is no longer valid. It is amazing how similar the stories are. You hear them from friends, family, and co-workers.
How many of us have said, ‘‘I just can’t take this anymore?” We often say this when we are scared and want out. It sometimes goes with statements like ‘‘I just want to be on the sidelines until things get better.’’
But we often find ourselves saying the same thing during raging bull markets, right before we ditch our plan and go for the next big thing. We just can’t take sitting on our boring, diversified portfolio anymore — not as tech stocks scream higher or a neighbor makes a fortune flipping houses.
One of the most dangerous stories is that we can somehow earn more from our investments without taking on more risk. There are always people offering investments they claim are as safe as a CD but that give you the higher interest rates you need.
You don’t want to buy into these ‘‘safe’’ products, only to be kicking yourself later for believing risk and return are no longer related.
So what can you do when you find yourself believing any of these stories?
Hit the brakes and remind yourself that only one story matters. Unfortunately, it’s a very boring one:
The key to investing is having a diversified, well-designed plan and sticking to it.