Last Updated Apr 5, 2009 5:38 PM EDT
Just consider "Black Friday," the day after Thanksgiving. The night before, people start lining up outside retailers so they'll be among the lucky first into the store when it opens at 5:00 a.m., ahead of the crowd and ready to fight for that widescreen TV at 50 percent off!
I'm all for buying things on sale, which is why I find it so fascinating that almost no one applies the same logic to investing. In 2006 and 2007, the market hit new highs and investors responded like a Black Friday mob on a shopping spree. Now that the stock market is on sale, investors have turned tail, yanking a record $234 billion out of mutual funds last year, according to the Investment Company Institute.
I long held that it's impossible to time the market. These days, though, I'm convinced that investors can time the market -- but are only capable of getting the timing exactly wrong. This applies not only to getting into and out of the market at the wrong times, but also to moving into hot sectors and countries at the wrong times. The data is very compelling -- investors are programmed to buy high and sell low.
Why investors behave so badly
Most people view themselves as thinking animals that happen to feel. There is much evidence, however, that far more decisions are made based on feelings.
In good times, investors tend to think of themselves as risk takers. Their friends say they're making money in the stock market, and no one wants to be left out. So they boldly go where every investor has gone before. Perhaps a planner has helped them form this self image of risk-taker based on that 63-question risk profile they filled out that indicated they should be 80 percent in stocks. And media gurus are always there to predict the Dow average will double or triple.
In bad times, investors see their nest eggs shrink along with their dreams and hopes for financial independence. The pain this causes is real in every sense of the word. And when the financial gurus jump on the doom and gloom bandwagon with their predictions, investors experience even more fear and pain. If they took another pass at that same 63-question risk profile then, they may find they feel very differently about risk and should only be 20 percent in stocks.
How do investors deal with this pain? Many take what's left of their marbles and go home. Just like in 2002, before the market began its five-year bull run, investors can be counted upon to panic and get out of the market.
Nearly everyone recognizes this behavior is irrational, but recognizing a bad behavior and changing it are two very different things. It's too easy to believe, yet again, that this time it's different. If you're feeling awful right now, remember that this too shall pass, though remembering how you're feeling can be valuable. Write down how you feel about investing right now and put it away in a safe place. Then, when the market has a couple of great years (and it will), pull it out and read it before you boldly put more into the market. Perhaps it will remind you of the pain you are feeling today.
Investing involves risk, and pain is the price of admission. How you deal with this pain is one of the biggest predictors of how successful you will be as an investor. Don't give into it.