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Wise Investors Stray from the Herd

William J. (Bill) Lynott |

When it comes to investing money, human nature likes to play tricks on us. When the stock market is reaching new highs, we can’t wait to jump in. When it stumbles and falls, we stop investing — or worse, start selling.
As a result, the typical investor tends to buy “high” and sell “low” — the opposite of a profitable investment strategy. But in spite of the lessons of the past, that inner voice keeps urging us to follow the crowd.
Decades of experience demonstrate that when a rising market starts to look like a “win-win,” it’s at its riskiest. And when the market mucks around in a slump, gloom and doom prevail, keeping many people from taking advantage of a “buy-low” situation.
The market boom of the late 1990s provides us with a classroom example of how costly our tendency to follow the herd can be. In early 2000, stock values soared to their highest levels in history. Investors were falling over themselves to get in on the action, and most of that new money was going to the investment darlings of the day, technology funds.
By the time the market peaked in March, investors had poured tens of billions into tech funds. We would soon learn that it was the worst possible time to invest: By October 2002, the S&P 500 had fallen almost 50%. Worse still, the NASDAQ — where many high-tech firms were listed — had lost more than three-quarters of its value.
Now for the “fun” part: With the market at its lowest point, investors started taking more money out of funds than they put in — human nature forcing many to look at the market as a sinking ship needing to be abandoned. The markets then began a slow recovery and reached a new peak in October 2007.
The moral of the story is clear: Listening to the inner voice that tells you to follow the crowd is often the worst thing to do when it comes to investing. When investors pour money into the market, it goes up — and we expect it to continue to go up. When the market falls, we expect it to keep falling. Human nature tells us that whatever is happening now will continue to happen. As we know, things don’t work that way.
What can you do to keep from falling into that “buy-high, sell-low” mindset? One strategy favored by financial advisors is dollar-cost averaging. The technique establishes a fixed dollar amount to invest at regular intervals (e.g., monthly); the investor sticks to the pattern regardless of market trends.
With dollar-cost averaging, your money buys fewer shares when the market is rising, and more shares when it’s falling. Since the market has a positive rate of return over time, the technique averages the cost of your shares over time to benefit from the market’s average return.
Another approach that seasoned investors like is the buy-and-hold strategy. With it, you buy only stocks with solid fundamentals, or mutual funds with low expenses and good diversification. Then, you stick with them in good times and bad. In other words, you ignore the crowd and avoid reacting to the emotion of the moment.
This can be tough to do when the market is diving, but following the herd is almost always the wrong move. While you can’t control the forces that produce market volatility, you can control your own responses to them. The best advice of all when it comes to your personal investment strategy is to stay focused on the long term.
There will always be news that provokes a reaction from investors. It may be a change in leadership in the White House, bad news involving a particular industry or a severe storm affecting the supply chain that exerts a short-term influence on the market. A long-term investor stays focused and avoids such short-term distractions.
The innate tendency to follow the crowd may come in handy in certain circumstances — it may pay to jump into a long line if someone is giving something away at the other end. But when it comes to investing your money, separating yourself from the herd will almost always work to your advantage.
 

About the author

William J. (Bill) Lynott

Freelance Writer

William J. (Bill) Lynott is a freelance writer whose work appears regularly in leading trade publications and newspapers, as well as consumer magazines including Reader’s Digest and Family Circle. You can reach Lynott at blynott@comcast.net.

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