Investors Time Their Beatings

Individual investors are busy people. Their lifestyles often don't allow them time to stay abreast of the current investment landscape, much less evaluate it. All too often, this results in people finding their way into the latest investment, well, late.

Did you pass on technology stocks as they soared, only to give in and purchase them just before they imploded? Did you buy your first real estate investment trust (REIT) or master limited partnership (MLP) three years into the largest bull run these securities have ever experienced? Most people did.

Money flows into tech funds were at their highest level just before valuations peaked in 2000. More recently, REITs such as Equity Office Properties (NYSE: EOP  ) and MLPs such as Kinder Morgan Energy Partners (NYSE: KMP  ) experienced a similar phenomenon. The Morgan Stanley REIT Index (AMEX: RMS  ) plunged more than 18% in April to May of this year on overblown fears of rising interest rates. Since then, however, the index has not only recovered that loss but gone on to further gains, so investors who sold in the rate-induced panic are the only ones who lost.

Psychology meets reality
Why do we do this? Why did so many individual investors pile into the market at its peak in 2000, then sell at its lows over the next two years, only to get back in after 2003's solid gains were largely in the history books -- effectively gaining, losing, then regaining their confidence exactly when they shouldn't have?

I believe it's a case of human nature -- compounded by very real time constraints. We wish to rely on experience, so we tend to look backward, not forward, when making decisions. We base the future on the past and often at the worst possible time. Consider that many bought tech stocks after six years of stellar gains because they felt that by then these investments were "proven."

Likewise, many investors only grew to trust REITs after they were already flying high. In investors' eyes, their success made them legitimate, just as failure -- at least in terms of a falling stock price -- had to be a sign of illegitimacy.

Couple this trait of human nature with the fact that many investors simply don't have the time to do the research necessary to formulate their own opinions, and you'll quickly see why so many are left making their decisions based on a combination of emotion and sound bites offered up by the financial pundits.

Time your emotions, not the market
I would say you should leave market timing to the pros, but there's no evidence that it's worked for them either. Actually, you timing the market is what works best for most financial professionals. Conveniently, these folks make more money when you become a more active investor. Coincidence?

Clearly, investors who go the timing route underperform those who simply choose a winning strategy and stick with it. I personally favor an income and growth approach that focuses on dividends, but as long as you make your choices objectively instead of subjectively -- and resist fear with logic -- your chances for success are greatly improved no matter your preference.

Now, I think it's important to note here that timing the market is not the same as plain old timing. There are a great many financial decisions that must be based on your investing time frame. So, forget market timing -- or the practice of jumping in and out of stocks or sectors because of the fear du jour -- but consider the timing of your holistic financial planning decisions very carefully. After all, timing in itself is important if for no other reason than that patience is important.

It's also worth noting once again that it's certainly OK to sell an investment based on intrinsic factors. The difference that I'm trying to stress here is that you should be selling based on relevant, logical information, not on the whims of the market seers. Sell your REIT because it's a bad REIT, not because the market says interest rates will bury these stocks despite the fact that they have historically had a very low correlation with interest rates.

When making your current investment decisions, you're typically better off looking at what the market is ignoring as opposed to what it is consistently talking about. This approach may not get you the easy short-term gains, but it will likely lead to you lapping your competitors over the long haul. Again, any decision that's based on reliable, factual information is a decision that you can feel good about.

This article was originally published on July 12, 2004.

If you're one of those folks who simply can't find the time to dig for winning investments, consider a no-risk free trial to Motley Fool Income Investor, which provides a minimum of two dividend-producing investment recommendations each month.

Mathew Emmert believes that investors mistake the scent of their burning portfolios for the smell of fear. He's the chief analyst ofMotley Fool Income Investor. He owns units of Kinder Morgan Management, the managing partner of Kinder Morgan Energy Partners. The Fool has a disclosure policy.

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