Going All Out

There is one action that has done more to hurt investors’ wealth than any others. I’ve seen it over and over again. The trouble is that the action is incredibly seductive, and it seems extremely logical on occasion.

But it’s based on gut instinct, which is provably unreliable when it comes to investing, and fails nearly every time.

What is this action that is so devastating to investors’ future wealth? Simply this: going all out of the stock market.

I beg you to avoid it.

Here’s just one example of a common scenario that I see. A presidential election is either about to occur or just concluded. The investor is either fearful their candidate won’t win – or the candidate has indeed already lost the election. The investor is so concerned about the future state of the United States under the wrong leadership that they are convinced the economy and the stock market are going to tank.

As a result, they sell every last one of their stock investments. They attempt to time the market.

From that point, one of two things happen. Both are bad, although it’s not always plain to see initially.

The first is that the market defies the investor’s gut instinct and continues to increase over time. I would venture to guess that outcome occurs at least 80% of the time. At that point, even if the investor swallows his or her pride and gets back into the market after the run-up, which rarely happens, they’ve permanent missed out of gains they otherwise would have enjoyed – thus, impairing their wealth.

More often than not, it’s even worse than that. Typically, the investor isn’t convinced they’re wrong until the market has moved against them significantly, over a period of time, which significantly diminishes their wealth. It’s brutal to watch.

The second thing that could happen is the market follows the expected path and starts to decline. This seems like a perfect scenario. The investor is proven right, and they dodged a dose of downside in their portfolio – thus, improving their wealth.

However, what happens next is where wealth is ultimately destroyed. In these situations, the market typically turns optimistic before the investor does. Convinced they are right, and puffed up by their initial correct market call, they double down on the action and remain fearful of an even deeper market correction.

That rarely happens.

What’s far more likely is that the market zooms higher, the investor misses out on the gains, and by the time the investor decides to get back into the market they are in a worse position than if they had stood pat the entire time.

Going all out seems smart. It usually seems rational. That’s why it’s so seductive. But it’s a terrible approach to investing. It’s too binary – with odds heavily stacked against the investor.

As a result, I often advise investors to “sin a little” when it comes to changing their portfolios. This is a phrase I grabbed from a research paper in the Journal of Investment Management.

If going all out is the ultimate sin, I recommend sinning just a little by making tweaks to the portfolio. Maybe sell 5% or 10% of your stock investments rather than the whole thing.

If you’re wrong about the market declining, you haven’t missed out on all of the upside. If you’re right, you’ll wish you had sold more but you won’t have the psychological baggage of trying to time when to get back into the market. It’s that second decision – to get back in – that’s often badly botched.

So, the next time you think the market is due for a fall, feel free to scratch that itch if you must by making a little change to your portfolio.

But please, please, please avoid going all out.