How to Avoid Losing Your Hard-Earned Money by Market Timing

Common Mistakes Made By Investors:

One of the most common mistakes that every investor makes once in his/her life is to time market. Neither investors, nor individuals, in fact no one is lucky or smart enough to make perfect calls every time. There is hardly any consistency in the decisions that are made by anyone.

Market Timing is driven by emotions and is a very typical reason why non-professional investors under perform professional managed investments. Everyone makes mistake once in a while, however, the best thing to do is to learn more these mistakes.

What is Market Timing?

The act of making buying and selling decisions based upon the prediction of future market price movements is referred as Market Timing. The investor who tries to time the market using market timing indicators most of the time tends to under perform as it is very difficult to predict future price movements of market.

Investors, when on their own tries to time the market, they usually end up buying or selling at worst time possible. When their decision ends up being a wrong one, they suffer the emotional trauma of the loss and fall in stock prices. Investors are more into making investment decisions when the prices happen to be at their highest. This is the reason most of the investors usually end up making worst decisions of their entire life.

There are strong evidences that can explain that the investors get influenced from the things mentioned above. The chart given below superimposes the data explain the flow of themoney i.e. into as well as out of the equity.

Stock-Market-Returns

Stock Market Returns

Fund-flows-in-mutual-funds

Fund flows in mutual funds

Correlation

It is important for you to note that when the prices were high, so was the returns, the flow of the money was inclined towards equity mutual funds. However, on the other hand, during the time of low prices, investors made withdrawals of the funds.

During the 1st quarter of the 2000, a lot of new money can be seen invested in the equity mutual funds. In 4th quarter after two years i.e. 2002, which was the bottom of the market due to decline in the prices of stock, investors went on to withdraw their money.

Moving on to the 3rd quarter of the 2008, which was also worst time of the stocks due to financial crises, the investors apparently decided to redeem an extraordinary amount of the equity mutual funds. This explains that the emotions of the investors make them to sell when the market is down and to buy when market is at its peak.

There are several studies held that focuses on measuring the cost investors pay due to bad investments decisions they make during bad times. According to all those researches, investors have tendency to do worse when they decide to avoid the timings of the market.

Another mistake:

The capital management gurus always have something to write about people who are into checking their portfolio on regular basis. According to them, making a routine of checking your profile on regular basis is not something that a wise investor would do.

The constant peeking in your portfolio is not good for your mental as well as financial health. According to different researches conducted on this certain behavior of the investors, the people who prefer to check the portfolios on regular basis usually end up under performing as compare to the one who check it once in a while.

There is no hard and fast rule about checking the portfolio every day. The only reason everyone advice against is that there is always a 50-50 chance when it comes to market going up or down.

According to the behavioural finance theory, people are more into fear of losing their money rather than the thrill of gaining something. This is the reason, people who check their profiles on regular basis, finds this entire process painful.

Seeing that the place where you wanted to invest your money might be going through little bit down, will affect your decision making. Checking portfolios on regular basis can cause you to panic and you might end up making decision in the spree of the moment, which is not always the best thing to do.

Now you might wonder what the solution to this problem is. Checking your profile less often than you already do?

Well, This Isn't Going To Change Much

We did our share of research on the history which goes back to 1871 and we can tell you that not checking portfolio isn't going to change things much.

For The Past 144 Years, According To The Probability:

  • 39% of the investor who prefer to check their portfolios only one time during entire month might end up seeing market going down.
  • Furthermore, checking portfolio once a year also comes with a 31% probability of them finding market in red.
market-timing

Now you might wonder what the solution to this problem is. Checking your profile less often than you already do?

Not your fault!

The first thing that you need to do is understand the fact that you are just a simple human being and do not posses any superpower that will let you know when and how to make perfect decisions for your capital management.

Mental weakness has nothing to do with the loss aversion. It is in fact a biological phenomenon. According to a study that was published in Proceedings of the National Academy of Sciences, the loss aversion is basically determined by Amygdalae.

The Amygdalae are basically two parts of brain in an almond shape that is important for the limbic system. The limbic system is the part of brain that controls the emotional life of a person. According to the study, people whose Amygdalae is damaged are not loss averse.

Do You Need To Remove Your Amygdalae?

Different scholars of the evolutionary psychology believe in the fact that the reason everyone is here is all because of loss aversion. According to the McDermott, Fowler, and Smirnov, loss aversion basically became one of the most important parts of human almost 10,000 years ago.

Different scholars of the evolutionary psychology believe in the fact that the reason everyone is here is all because of loss aversion. According to the McDermott, Fowler, and Smirnov, loss aversion basically became one of the most important parts of human almost 10,000 years ago.

However, it is important for you to know what capital investment portfolio and lack of food aren't same things. The lack of food is basically an immediate problem while a small lose in your portfolio isn't an immediate problem.

Looking at total return, which includes dividends, since 1965 for the S&P 500; the average annualized return was 11.20%. But what really is interesting is how well stocks performed when compared to inflation.

Inflation decreases the value of your money and investments are only really profitable when they beat it on a consistent basis. Average annualized inflation-adjusted return for the S&P 500 over the same period was 6.96%. This means that $1 invested in 1965 would now be worth $15.16 when adjusted for inflation.

That number may sound underwhelming, but if you consider that as it discounts inflation, the multiplier of 15 gives the increase in your actual purchasing power. In Money terms, as annualized return for this period was 11.20%, $1 would have grown to $114.89.

So a portfolio of $10,000 that had been invested in the broad stock market in 1965 would now be worth $1,148,900. With this number, it is perhaps easier to appreciate the extent to which the stock market actually beat inflation. ( Read more at Long Term Investments )

market-timing

What You Can Do?

There are different researches conducted to explain what investors can do when it comes to checking capital investment portfolio. The best thing that they can do is make a plan, a rational one and stick to it. Committing themselves to the rational plan will help them to rise over their emotional imbalance.

Investors Can Do Following Things:

  • Sticking to an asset management or wealth advisor service, so that they can simply give the hold of trigger to it. Look for an asset manager with low yearly cost, as you need to hold the portfolio for years especially the yearly cost is important.
  • Training their mind to invest when the market is down, as low price capital management can bring in huge profits in the long run.
  • Your money will be in stocks and longer downturns can be psychically demanding, even if you know that it will go up anyhow sometime in the future again. Look for additional trading strategies which are not related to the stock market but have a positive return expectation. This can be commodities or alternative investments.

Of course, it is not easy for every investor to follow above mention tips. However, if they do, the pay-off is usually worth every penny.


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