Just because something is simple, that doesn’t make it easy. For example, it’s simple to win an Olympic Gold Medal in the 200-meter race. You just have to run the fastest.
Joking aside, I see investors employing this same false logic in how they interact with the markets. They operate on this basis: It’s simple to win at the markets; you just have to buy low and sell high. In other words, time the markets, take advantage of a dislocation of some sort, bet big and cash out. However, if your investment plan requires you to be the smartest person in the room, think again.
In my opinion, investment strategies that require you to be smarter than the market never work in the long haul.
First of all, consider your competition. Every day there are full-time professionals – some paid tens of millions of dollars a year – trying to get an edge on the very stocks you’re trading. To make money you need to be better than these professionals. In other words, to win at the investment Olympics you need to be able to run faster than the current world record holder.
Second, the empirical evidence is against you. Academics have told us this before. No less than the American Finance Association has proved it in studies.
Third, many brilliant people — those who really were the “smartest in the room” for their time – have failed in timing the markets. Perhaps one of the most interesting examples of the phenomenon, is the story of John Meriwether and Long-Term Capital Management. Meriwether, who was no intellectual slouch himself, hired not one but two Nobel Prize winners (Myron Scholes and Robert Merton who shared the 1997 Nobel Memorial Prize in Economic Sciences) to help him devise a way to beat the market. In 1998 the company lost $4.6 billion which affected so many financial institutions that it required intervention by the Federal Reserve.
To succeed at timing the market, you need to be smarter than these guys, willing to take a catastrophic loss and hope you still have enough to bounce back from a debacle.
In my practice, I spend a lot of time talking clients out of playing the market. Almost invariably these are people who have had tremendous success in their line of work and believe they can translate that success to investing.
When I hear this, I tell them about how the “smartest” people did and I remind them that they’re talking about doing this part time.
I have one client, a brilliant surgeon and I put it to him this way. “How much faith would you put in a part time heart surgeon, someone who only does this a few hours every week?” I explained to him that is the position he was putting himself in.
Today’s financial markets are chock full of full-time investors who have (nearly) infinite resources and yet even they can’t consistently win. How could someone beat them only spending a few hours a week on it?
In my opinion, timing in the short term is impossible. The best time frame to work with is 5-7 years.
Next , you need to do the simple things – follow your investment plan, stay humble, keep emotions and ego out of your finances — over and over, just as an athlete needs to stick to a training regime for years in order to have a shot at the Olympics.
Finally, not trying to time the market is really how you win the race. It’s that simple.