Buy low, sell high.
Yawn. Ask any investor, anywhere in the world, at any level of net worth, and they’ll tell you that this is the way to build wealth and create financial freedom. It’s fundamental. It’s basic. It’s cliche.
But then, why do so few investors actually do it?
Because the data shows that, on average, investors do the opposite. They buy more when prices are high and sell when prices are low. Far from being a path to wealth, investing in this way is a surefire way to get burned and lose money on the markets or at least achieve underwhelming returns.
Don’t believe us? We’ll show you the data that backs this up and explain how and why you should be investing more when prices fall, not pulling money out.
The graph below shows the total money going into equity investment funds, overlaid against the performance of the total market over the past 12 months.
Inflows are basically everything that is going into any form of equity fund. So it includes investors paying money into ETFs on a trading app, financial advisors placing funds on behalf of their clients and even investors moving money in and out of equities within their pension funds.
Essentially, it’s money moving in and out of the stock market. So if we look at the very first bar in 2000, we can see that an average of $20 billion of new money went into the markets each week over a six-month period. During the next six-month period, that average went up to just under $30 billion dollars a week.
We can see a pretty clear and interesting pattern in how this money moving in and out of the market relates to the performance of the stock market. When markets are falling, money starts to move out of equities.
One of the most obvious examples is in 2008, when the financial crisis saw billions of dollars rush out of stocks every week. But we can also see the same pattern in the early 2000’s and in 2011.
The opposite is true as well. When markets are performing the best is when we see the most funds moving into equity markets. The tail end of the dot com boom saw $35+ billion going into the stock market each week, and the peak of the bull market in late 2003/early 2004 saw inflows of over $20 billion.
The only real exception we see over this time period is the rapid recovery post-2008, as investors were still too scared to get back in. Even so, when markets fell again in 2010, even higher volume of stocks were sold.
So the data doesn’t lie. Investors aren’t buying low and selling high. They’re buying high and selling low.
The reason for this comes down to emotion. Most of us like to think of ourselves as completely rational thinkers, able to look at the data and the landscape and make decisions that are sensible and well thought out.
That might be the case when we’re talking about something abstract that doesn’t directly impact us, but as soon as the decision is something that could impact our own personal lives, (and especially if it might impact the ones we love like our partner or kids), rationality goes out the window.
It’s been scientifically proven that humans feel the pain of loss far more strongly than they feel the satisfaction from a gain. Losing £10,000 on a bad investment feels significantly worse than the good feelings brought by a £10,000 gain.
While many intelligent people will understand the concept that they should be putting more cash into the markets when they’re at their worst, the perceived risk of doing it is very hard for most people to overcome.
It’s easy to look back in hindsight and see that staying invested during market crashes has always resulted in a full recovery, but it’s much harder to look at a portfolio that’s down 20% and do nothing. Even though that's almost always exactly what investors should do - put in additional cash.
That’s also why during almost every market crash or economic crisis, we see a string of news headlines and talking heads explaining why ‘this time it’s different.’
Spoiler: it never is.
Sure, the specifics of how a crash is triggered and how it plays out are always variations on the theme, but the fundamentals are the same. Markets fall, investors panic, markets recover, and investors rush back in.
So as an investor, how do you fight this urge? How do you structure your investments in a way that removes your own emotions (as much as possible) from the equation?
Well, there are a number of different strategies or layers you can add to your investments to help keep you focused on the long term instead of worrying about the latest ‘crisis.’
This is the simplest way to avoid falling into the trap. Pound cost averaging is when you automatically direct your surplus cash flow into your investments each month. You don’t adjust it based on the markets, you don’t try, and time the payment, you just set up a direct debit once and then forget about it.
The benefit of doing this is that the amount you buy automatically shifts as the price of the investments changes. Say you start your portfolio when the cost of 1 unit of your chosen fund or ETF is worth £100, and you decide to contribute £1,000 per month.
In month 1, you’ll buy 10 units for your £1,000.
Then say next month, the market rockets and each unit goes up to £150. Now, your £1,000 will only buy you 6.67 units. You’re buying less as the price rises.
The month after that, markets crash, and the unit price goes down to £50. Your £1,000 for that month will buy you 20 units, meaning you’re picking up more holdings as the price is lower.
It automates the exact behaviour you want to follow, buying more as prices fall and buying less as prices rise. It means you’ll buy the most number of assets when prices are at the bottom and the fewest when they’re at their frothy top.
Of course, this is all well and good, but if you’re pound cost averaging and then constantly messing around with your asset allocation, it's going to negate the benefits.
Trying to individually pick stocks is going to lead you to the exact same problem. You’ll almost certainly be looking at getting in on companies that have already experienced major price rises and be looking to shift out of stocks that have crashed.
Again, this is often the exact opposite of what you want to be doing, but with an additional layer of risk.
Instead, you should be utilising the services of a professional investment manager. This can be done through buying an ETF or fund, or seeking out a specific individual or company to manage your portfolio for you.
Both of these strategies work, but they have a big blind spot. They both still rely on you staying the course. It’s easy to switch off your direct debit or start buying and selling ETFs. It’s a slippery slope and there’s not really a suitable middle ground.
That’s where a professional financial advisor brings in value. They create an additional barrier between you and your financial decisions, allowing you to outsource the management to someone who isn’t emotionally invested.
This is in addition to the tax benefits and strategy advice a good advisor can offer, which can add up to hundreds of thousands, even millions, of pounds over the course of your life.
The best part is that this benefit has been quantified. Vanguard (the second largest fund manager in the world) analysed a large number of portfolios that were self-invested and managed by an advisor to assess the value added by a professional.
They put this total amount at 3% p.a. on average. The biggest component of that benefit was what they called ‘behavioural coaching,’ which provides an estimated 1.5% p.a. in additional return to investors.
Simply put, advisors stopped their clients from buying and selling when they shouldn’t.
So as you can see, behaviours and emotions play a major role in successful investing. Ignoring this and sticking to what appears to be the black-and-white fundamentals and data, is likely to end investors with a worse financial outcome.
That means longer to achieve financial freedom, a smaller pot when they get there, and less options with how they live their lives on a daily basis.
If you want to invest differently, speak to Rosecut today.