This Is Why You're Not Making Money in the Market

OK, let's be straight here. I obviously don't know whether you personally are beating or lagging the market. But with a great many professional money managers failing to keep up with the market, it's not much of a leap to assume that plenty of individual investors have found themselves eating Mr. Market's dust, particularly during the crazy rally over the past eight months.

For those of you scratching your heads and wondering why you can't seem to figure out the crazy stock market, an article from CNBC yesterday might go a long way toward elucidating the situation. The thesis of the article was that investors who are still hesitant after the market's crash are slowly starting to creep back into the market:

Investment advisors say clients continue to view stocks with hesitancy and skepticism - a vestige of the panic that swept through the markets just a year ago. But that fear, ironically, has kept stocks from going up too far, too fast - allowing the market to move gradually higher as investors creep timidly back into stocks.

And that is the problem
"Buy low and sell high" is the supposed mantra of most investors, but many individual investors find their emotions swinging more wildly than the bottom of the batting order at a 4-year-old's tee-ball game. When times are terrible and valuations are low, fear takes over and causes them to sell as fast as their mouse button can click. But when recovery hopes are high and everyone is feeling more bullish, these same investors find themselves willing to pay up for many of the same stocks they sold in a panic months earlier.

Of course, it's not surprising in the least that that devilish imp Greed is goading investors right now. Looking at the returns of some stocks, you'd think making money in the market was as easy as buying a cup of coffee.

Source: Capital IQ, a Standard & Poor's company.

And while the recent returns may be somewhat higher because the drop-off was so steep, these kinds of gains aren't all that unusual following a market downturn. Check out what happened to these stocks in the eight months following the bottom of the dot-com blowup.

Source: Capital IQ, a Standard & Poor's company.

Over that time, the median return of the 100 top-performing stocks came in at just under 97%, trouncing the 22% that the S&P 500 index provided. But here's the catch: In the three years that followed, the median performance of that same group clocked in at a hair under 22%, below the S&P's 29% gain.

Investors looking for easy money who charged back into the market after the first eight months of the post-dot-com rally may well have found themselves seriously disappointed.

Bulls make money, bears make money, and lemmings go splat
One possible takeaway from this story is that if you don't have the time or emotional fortitude to properly mind your investments, you may be better off handing over your investing duties to a professional. Assuming, of course, you find one you can trust to do the job right.

If you're dead set on managing your investments yourself, though, you probably want to keep a couple things in mind:

1. Performance yesterday doesn't mean performance tomorrow. Just because a stock has had a huge run doesn't mean that it's destined to keep going. In fact, it could mean that the stock now carries a huge, unsustainable valuation. So instead of drooling over the stocks that have taken off like an arrow, now may be the time to check out high-quality companies like Wal-Mart (NYSE:WMT) and PepsiCo that have trailed the market over the past eight months, but still stand to benefit from economic recovery.
   
   
2. Avoid panic buying or selling. I hate to do it, but I have to break out this classic mom line: "What if everyone else jumped off a bridge? Would you do that, too?" Just because everyone else is buying or selling doesn't mean that you have to. When it comes to the stock market, things are rarely as bad as they seem in the worst of times, nor are they as good as they seem during the best of times.

Still worried about missing the rally? Fellow Fool Paul Elliot has some thoughts on what you can do.