The following article is a guest post by our friend William Cowie. If you are interested in guest posting, please be sure to read our guest posting guidelines.
“Mom, it wasn’t me!” (Or Dad)
When that’s the first thing that you hear when you arrive to pick up your kid, what’s your reaction? To believe your child? “Oh sure, Honey, it could never be you! Come here and give Mommy a kiss. Did you enjoy your lunch?”
I didn’t think so either.
Why not? Because you know human nature. You remember: as a kid, when you get caught doing something wrong, your first instinct is to defend yourself, especially when you’re guilty. Admit it: you still do that when you see a cop car in the rear view mirror — even if they haven’t turned on their lights. We all do it. It’s in our nature.
Stop and think about it for a second, though. If your kid came to you and said, “Dad, I really, really messed up. I didn’t mean to but I really messed up.” What’s your first reaction? Don’t you just want to forgive them and say it will be all right? If kids were smart, wouldn’t they go against their instincts and do what gives them a better outcome?
We’re adults now. At least the IRS says we are when they want our money. You would think we’d have learned by now that it’s better to do the smart thing rather than the instinctual thing.
You’d be wrong of course. At least when it comes to our money.
Investing Advice: Buy Low, Sell High
No doubt you’ve heard Warren Buffett say one of the keys to his success is “buy low, sell high.”
And no doubt you agree. Smart man, smart advice. Something we’d pass on at a dinner party, along with a sage nod of the head.
But… do you follow that advice? Really… do you actually follow that advice? I’m wagering you don’t. Why not? Because you’re a normal human being, and normal human beings usually don’t do what smart people say we should. (That’s why those are the people they call smart.) I know for years I didn’t.
Well, isn’t that just a pretty accusing thing to say? We hardly know each other and here I am leading right off with: you’re not following the advice you espouse.
Let’s see if I can back that up.
Sell High
What am I talking about? Investments — that’s what Warren Buffett referred to when he said one of his secrets to success was: buy low, sell high.
Whether we invest in stocks, CDs, bonds or rental houses, we almost all buy a dwelling at some point. So let’s use home buying as a proxy for all investing.
When were prices at their highest? A few years ago, right? Around 2006-2007.
What did people do back then? Did they sell high?
No, they bought! Even the ones that sold immediately turned around and bought another house (or two). While their mouths said sell high, their checkbooks said buy high. And, as we all know, checkbooks speak louder than words. (Tweet that!)
So what happened to “sell high?”
Three things happened. They always happen when prices are high.
- No matter how high prices get, they’re never high enough to get us to sell. It’s called greed. Bulls and bears and pigs — you know the saying.
- Peer pressure. There’s no pressure like sitting at a dinner party listening to three people around you bragging about the money they made flipping houses, classic cars or whatever. It’s easy money… and you feel stupid for passing it up. So you buy high. Peer pressure beats sound logic every time.
- The forever syndrome. It’s human nature to project today into the future. If it’s snowing outside, it’s almost impossible to pack summer clothes for a trip to the Bahamas. In the same way, when prices are rising, it’s almost impossible to think they’re going to crash. Which makes it easy for #2 to lead to #1.
Now we begin to see why so many people find it so hard to sell when prices are high.
Buy Low
So, is buying low any easier? Nope. When prices crash, they crash quickly. Billboards and signs everywhere proclaim 30% off on everything, from cars and carpets to Caribbean cruises. There’s always a Circuit City that goes out of business in these times, with closeout bargains to make your mouth water. Same with builder bankruptcy auctions.
So when prices crash, you would think everyone would jump on all these bargains. As before, you would be wrong.
In Economics 101 you heard about the law of supply and demand. When prices drop, sales go up, right? I hate to break this to you, but you were lied to. The learned people who wrote those text books never lived through a recession. Prices drop to their lowest points ever, but so do sales. No demand.
Why, when I suggested to my friends two years ago that I want to go to a foreclosure auction to buy a rental house as an investment, did they go ballistic? “Are you crazy? Who invests in houses now? Didn’t you see how their prices dropped? Nobody is stupid enough to buy a house in this environment!”
Hasn’t anybody heard of buy low? Why are people not lining up out the door to snap up these bargains?
Again, there are good reasons why people don’t buy low, again all rooted in human nature.
- People are broke. That’s not human nature, you might say; an empty bank account is an empty bank account. It still is human nature: the bank account is empty because people didn’t sell when prices were high and that, as we noted above, is because of human nature.
- Times (and people) are “uncertain.” Have you noticed this? When prices are rising, the times are never “uncertain.” It’s only when prices fall that times are called uncertain. Who made this up? Who said we’re certain about the future when prices are inflated, but we’re uncertain when they reset to their proper levels? Polling companies? The media? I don’t know, but here’s the bottom line: when people feel uncertain, they hang on to their money. This thing that “people don’t have money” to snap up the bargains of the recession era, sorry, that’s pure baloney! Cash deposits in banks actually climbed through the recession, just look at this chart from Federal Reserve Bank data, which shows bank deposits rising from 2008 to 2010. This uncertainty they talk about, it’s just simple fear. When prices rise, people get greedy, when prices fall, they get fearful.
- This is the same as #3 above: people project today into the future. If things are bad today, they assume things will remain bad in the future… unless they get worse, of course. But… we all know every recession has always been followed by an upturn. Every single one. Just like every bubble was followed by a crash. So the fear is ungrounded, just as the eternal optimism of the bubble season is unfounded.
So we see human nature makes us not buy low and not sell high.
When
Remember your kid in the opening who said it wasn’t him? (Has to be a him — little girls never get into trouble!) When you missed the opportunity to sell high in 2007 and then buy low in the recent recession, it “wasn’t you”: you didn’t have the knowledge of what to overcome in order to truly benefit from the riches the economic cycle presents to you.
But now you know: the obstacle is our human nature. (We have met the enemy and he is us.)
Don’t feel alone. It took me 40 years to figure this out and overcome it. That’s the bad news. When I did figure it out, though, I made up for those 40 years in one single cycle. That’s the good news — this is powerful stuff!
We’re in a recovery now, backed by a Fed determined to do whatever it takes to keep it going. So you have a few good years left before the next bubble and crash hit. Nobody knows what the bubble will be this time (tech stocks in 1999, houses in 2008) but we know there will be one. And after the bubble there will be another crash. Not the end of the world (despite what people say) — just the normal up and down of the economic cycle.
So, now you have a few years to prepare. Time to get out of debt, plan what to sell in the next bubble (everything) and then load up that war chest with plain old cash. Then, when the next recession strikes, you’ll be armed and dangerous: willing and able to go out and buy up the world at 30% off. As Sandra Bullock told the coach in The Blind Side: you can thank me later.
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William Cowie learned the hard way to overcome human nature and he emerged from the recent recession in the best financial shape of his life. Pick up his free how-to, which expands on these concepts, at http://www.dropdeadmoney.com.
I don’t have the emotional strength to swallow the market’s up and downs, like many I guess. I tried going into stocks and realized that since I couldn’t outsmart the market and have what it takes to keep my winning positions long enough, my best bet was to set aside a regular amount each month, that would average my buying cost and take anything personal and emotional out of the equation. You are very right saying that one can buy the world at 30% off, and I think there still are a few bargains to grab before the bubble forms again.
Pauline recently posted..Snowflaking my way through September
Pauline, you’re right, there is still time. As long as we all understand that the growth we see now won’t last forever.
Very thorough post about how our human nature totally comes into play with investments (just like everything else in life). You said “Nobody knows what the bubble will be this time (tech stocks in 1999, houses in 2008) but we know there will be one.” and I would argue that the next bubbles are the government debt and dollar bubble. I essentially agree with the author’s of “Aftershock” in their assessment of where we are going over the next 5 years.
DC @ Young Adult Money recently posted..What is the Dow Jones Industrial Average (DJI)?
You may be right. But we still may see something “ordinary people” chase with more money than brains. It’s still early. But then again, this particular economic cycle is so unique compared to previous ones, it’s going to be hard to predict anything about it…
Hi William – Congratulations on presenting the ‘Human Element’ so well. I think the lesson that I will take out of this is that
1. Sell high does not just apply to stocks
2. Reinforcement of your video that recessions are cyclic!
Savvy Scot recently posted..The Sunday Review – Top Posts of the Week
Very thorough post on the economic cycle and how human nature causes us to go broke instead of rich. William, I think you are correct in your assessment.
Although, I disagree that economic cycles will continue forever. They are caused by the Federal Reserve’s manipulation of the money supply. At some point I think the public will wise up and abolish the FED. (At least this is my hope). But in the mean time, one can be successful in the market if they can predict the cycle.
Jason Clayton | frugal habits recently posted..5 Easy Methods to Save Money without Thinking
Great post William. As a society we have been built on greed. No matter how much we know about selling high, it’s never high enough. People like to squeeze every point of gains out of the market that they can. It is truly just human nature. Is it going to pay off some of the time, of course. It’s also going to bite us in the butt.
I try and be a focused as I can on a strategy when investing. If its not a long term portfolio then I always take money off the table when a market runs up 5-10%. Of course I will lose some gains but I will also save myself heartache if we have a big correction. The market is too volatile these days.
Man, I agree with you on the volatile (and odd) market these days. I have a very healthy portion of my portfolio in cash these days. I know I may miss some on the upside, but this market is scary enough to not chase the last dollah…
It’s funny about the ‘uncertain’ times things; I never thought about it, but that’s definitely what they say! Times are uncertain when things are low, and times are great when theyr’e high. But actually, nothing is uncertain about it. It’s low. That’s it!
TB at BlueCollarWorkman recently posted..What Happens to Kids Who Were Bullied?
Great post! I find that even the best laid, most rational plans also fall prey to foolish decision making. In regards to Buffett, I like to follow another one of axioms…buy the fear and sell the greed. If you bought the fear in 2008, you’d be generally sitting nice right about now.
John S @ Frugal Rules recently posted..Find Financial Safety With an Emergency Fund
And this is true not just for stocks. Most people, when they hear this, equate it to stocks only, but it’s a general truth. For example, if you have an idea in your mind that you want to take an around the world cruise, a recession is the best time to do that, because that’s when you get those killer deals. Or a bass boat, a new ski outfit, kitchen appliances, the list goes on and on.
I’m thankful that I’m young and have time to weather a few storms and buy low when the market tanks. I know the fundamentals; I just hope I can put my emotions aside when the time comes!
Jason @ WorkSaveLive recently posted..The Rise of the Female Trader
Jason, you nailed it: there are two big dangers people face when it comes to this issue: (a) they lose sight of their own tendencies, and (b) they miss the (very) slow changes in the economy until it’s too late.
Disclaimer: shameless plug ahead: The mainstay of what I do is a quarterly heads-up newsletter for email subscribers which reminds people of both. [In my defense, I'll point out that it's free.
]
William,
Spot on advice. I lost money in the stock market crash because of exactly what you’re talking about. (“But it could go higher, so I’ll hang on just a little longer!” Ugh.) Thanks for the wisdom.
Deonne
Deonne Kahler recently posted..Want To Make A Change But Aren’t Sure How? Start Here.
I think the media doesn’t help. With all the doom and gloom being broadcast, people who don’t necessarily study the market might feel like they need to jump ship when things are down.
Kim@Eyesonthedollar recently posted..What You Need and Don’t Need For New Baby
Kim, you’re right. That’s an enormous problem, for two reasons:
(a) the media in general has a bias toward the negative and the sensational. (Good news is no news.) It is what it is, and we just have to aware of that and put on a filter against it.
(b) the march up the positive curve of the economic cycle is slow and long, and there’s little that’s newsworthy about it. The slide down, though, is usually swift and dramatic, and that lends itself to the sensationalistic news appetite.
The bottom line is you can’t rely on the media to guide you toward good financial decision making.
I recon one would never make it in forex trading if emotions played any part of decision making. Leave emotions out!
Veronica @ Pelican on Money recently posted..Just Do It
I plan on teaching my son all about investing.
There is no way I would be able to have paid off as much mortgage debt as I currently have if it wasn’t for stock & forex investing/gambling…
I only have a couple of rules –
1) Stick to your rules.
2) Put in automatic rules. It takes the emotion out of the equation.
3) If you can only handle a 10% loss then put in a stop loss order.
4) If you want to maximize profits use trailing stops
5) If you want to make only 10% profit then put in an auto sell at 10% profit.
Don’t change your rules in the middle of the game. You will always end up losing in the long term.
Glen @ Monster Piggy Bank recently posted..The cost of funeral insurance
I would love to be patient and wait for the high before I sell. Only, I’m anxious how long it will take for this anticipated rise in prices of stocks. I hope it doesn’t take years.
CreditDonkey recently posted..Credit Cards Too Private to Recommend
Loved this blog post. I plan on teaching my kids investing. Once they are slightly older, I might ask them to invest money and track their performance. This way they can get a real world experience.
Buy & Hold Blog recently posted..Actively Manged Funds vs. Index Funds