You've done it. I've done it. She's done it, and he's done it. And so's your old man! I'm talking buy high, sell low, baby. I'm talking LOSE MONEY.
For some investors, this just feels inevitable. Some are convinced that as soon as they buy a stock it will drop. Of course, just after they finally decide to sell that stock, it'll go back up. And in many cases, it must be noted, this phobia is quite logically rooted in their direct experience! "World's Worst Investor" they then label themselves at the bottom of their posting, or email, with Foolish self-effacement. Even Rule Breaker co-manager Paul Commins wore that mantle in Wednesday's column.
Is it karma? Divine intervention? A family curse?
Nah. Just human nature.
In my experience, we humans rate good to excellent at looking backward. To an inordinate degree, the last several days, weeks, or months color our viewpoint. And this is as it should be, right? We should be living and learning as we go, drawing conclusions about what works and why.
The problem comes in when we apply this commonsense and no doubt naturally selected mechanism to our investing. We invest with a rear-view mirror, particularly one that only looks back a few months -- to the exclusion both of a broader historical context and of a realistic future expectation.
That first month after making an investment, if the stock drops, we grow slightly dispirited. But that's not yet enough to cause us to sell. It's when it continues down over the ensuing weeks or months that finally we decide things have gotten so bad that we at last do sell -- at the bottom.
You see, in many cases we were buying a good company like Schwab (NYSE: SCH) or Home Depot (NYSE: HD), whose stock just had a bad few months. When you buy rock-solid companies, most of 'em rise with their profits over time and therefore come back from their haphazard plunges. But because we tend to draw conclusions from our recent past and then take action on them, we sell our Schwab or Home Depot and conclude that we blew it. Our own self-regard declines farther as we then watch those stocks (whichever stock) rebound back to new highs, sans our money.
Sometimes we justify the sale by citing something more fundamental than simply a falling stock price, like after the company misses an earnings estimate or loses an important client. We have a tendency to magnify the importance of temporary business problems, since there is no clear future path for the company. Investors will even sell off companies with a long history of overcoming difficulties in such cases, as they did Johnson & Johnson (NYSE: JNJ) after the Tylenol scare in 1982, as well as when the company pulled Propulsid off the shelves in 2000. But those were great opportunities to buy J&J, and terrible times to sell.
Conversely, we hold off buying a stock as it rises from $17 to $63. We read the headlines, we see the Wall Street "strong buys," note the announced stock split, and we finally throw up our hands and say, "No mas! Enough!" And buy. And that very day marks the stock's peak. You've done it. I've done it. And so's your old man.
We react -- in some cases we overreact -- to what has already happened. We lack the vision or capacity or will to look forward. Forward hasn't happened yet! Backward already has. Which of these two, we naturally ask, is more convincing? From which can we more easily extract data to galvanize us to action?
Perhaps you already know this, in which case I ask your forgiveness. But if you are someone who voluntarily wears the "Kick Me" button or the "World's Worst Investor" T-shirt, I say these frequent backward looks are probably the root of your problem. Thus, be patient. Look ahead. In many cases -- and I am generalizing here, I know -- you will be better served by buying into and holding onto your shares of a good company than by using the last three-to-six months of stock performance as your dominant influence.
The answer is to be a Fool. That means subverting your natural instincts (most people want to be "Wise," no?) and inverting the situation. Rather than ask, "Where have things been?" distinguish yourself from the rest of your species and say, "N-, n-, no... where are they going?" Chances are, after a 25% sell-off, that neither Schwab nor Home Depot have lost 25% of their relevance, market share, or profit potential.
If you know your company well, don't be bothered by swings in price. Warren Buffett said not long ago, "It doesn't bother us if what we own goes down 50%. In fact, we like it -- we'll buy more.... Once you think the market is telling you whether you're right or wrong, or once you're looking to the market for guidance, you're in trouble."
Don't spend your whole investment life chasing stocks merely because they've already risen, and systematically ditching what's already been sold off. Learn from your fellow Fools (so many great Dumb Investments to learn from). Stay well away from the Church of What's Already Happened.
And sorry if I insulted your old man.
(Quiet miracles happen every day in our community.)
Finally today, an error I made in my "Our Friend, the Trade Deficit" column occasioned a note from my Dad, who is a retired lawyer and lifelong student of the Federal Reserve System. Based on my reading of Basic Economics by Thomas Sowell, I had written that services are not included in the trade deficit. But that depends what you call "the trade deficit." What most people refer to as the trade deficit is the "balance on current accounts" and for this figure, the important and relevant one, services are indeed included. My blame, not Mr. Sowell's. My father corrects my mistake but goes on to provide further thinking on the trade deficit. His note is of interest to any student of the economy or fan of economics. If this describes you, I hope you'll click this link. And please join us for discussion on the Economy & Markets discussion board.
David Gardner, June 8, 2001
David Gardner is co-founder of The Motley Fool, which is investors writing for investors.