Harry sells $30,000 worth of bonds–then fully exploits someone else!
Harry realizes that, in the stock market, there’s always a buyer for every seller. He sighs and wishes, in one sense, that it wasn’t true. For Harry to do so well, he has to take advantage of other people.
For example, this week he sold $30,000 worth of short term Canadian government bonds, and he used the money to buy the international stock market index (XIN.TO) and the U.S. stock market index (XIC.TO) Somebody—likely somebody afraid of the falling stock markets—sold those stock indexes to Harry. It could have been the same person Harry sold his bond index to. Pity them.
They were probably afraid to see the markets drop 10% during the past ten days, so they unloaded their Canadian and International stock index holdings to buy a safe, short term Canadian government bond index. They didn’t care that they were selling something cheap to buy something expensive. They based their decisions on fear, instead of logic.
Harry coolly sips at his beer and explains:
“My little balanced portfolio will beat more than 95% of balanced actively managed mutual funds. And that figure might even be conservative.”
Pressing for an explanation, Harry continues:
“Most investors, including most professionals, aren’t logical. They’re cowardly. But their cowardice sends them running to the fire instead of away from it.”
Then I pressed Harry, to see if he was scared of the upcoming situation that Europe was in, courtesy of Greece:
“Come on, don’t be silly,” he said. Nobody is going to remember this little economic blip years from now. It’s going to be a non issue.”
“Quick,” Harry shoots at me, “How far did the markets drop after some nutbars hijacked a couple of airplanes and flew them into our symbols of American capitalism in 2001?”
“How far did the markets slump when George Bush pushed the U.S. into a War with Iraq in 2003?”
“Can you guess, within 500 points, what level the DOW dropped to last year?”
“Humans,” suggests Harry, “aren’t wired to invest money. Most of them react fearfully without a sense of history, and without any kind of long term memory at all. Perfectly rational people react irrationally when it comes to money. When the markets fall, it’s a sign that there are more sellers than buyers. And when the markets rise, there are more buyers than sellers. It’s that simple. People and their craziness is what move the markets.”
Harry then went on to suggest that no amount of financial training or education can make you a good investor. “A few people are born to do it,” he says, “But if you aren’t born to do it, no amount of financial education is going to give you the ability to think independently and logically. Whether you manage your own puny portfolio or a multi-billion dollar mutual fund, if you’re not born to invest, you’ll react like a lemming. “
“Real investors,” he continues, “take advantage of the fears and greed of others. That’s just the way it is.”
What do you think? Is Harry right?
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Andrew Hallam says:
June 2, 2010 at 11:29 am (UTC 8 )
Financial Cents
I absolutely love that recipe. And I think you started off with the most important ingredient of all. Great turn of a phrase, ” Rinse and repeat as often as you wish and can afford.”
I should call you the investment Buddha!
Cheers,
Andrew
Monevator says:
June 2, 2010 at 3:27 pm (UTC 8 )
@Andrew Hallam
Andrew, thanks very much for your generous assessment of my writing! And of course for highlighting my post. Much appreciated.
Monevator says:
June 2, 2010 at 3:43 pm (UTC 8 )
@DIY Investor
Thanks DIY Investor. It still goes on – I heard an anchor on CNBC asking a value investor yesterday if he was sticking by his decision to invest last week/month now the US market had fallen c.15%, or was he put off by the volatility! Er, no. He was not put off!
Kevin@InvestItWisely says:
June 2, 2010 at 9:32 pm (UTC 8 )
Andrew,
What happened to your site! I can barely keep up with all of the new comments!
I can understand your frustration; given everything that you know, it must be so easy to see the mistakes that your friends make, and frustrating when they listen to your advice, acknowledge it, but still give in to their emotions. Sometimes, emotions can get the best of us.
What you said about DIYInvestor’s method is interesting. When we start bicycling as a kid, many of us need tricycles in order to not fall over. After a while, we are ready to set out on their own. I believe that most people can get the basics down (after all, the most basic investing strategy is fairly easy: buy an indexed fund and hold. You can gradually add other concepts like asset allocation down the road).
I believe that many people simply think it’s more complicated than it has to be because they read about all sorts of esoteric terms when they read about it in the paper or on the internet, or especially when they talk to their advisor. The truth is that you don’t need to be a pro or be particularly talented to do well in the markets: you simply need to stay the course! Even someone just holding indexed funds alone still does much better than someone going in actively managed funds or worse, market-linked GICs (I see no point at all to these if you are investing for the long term).
@DIY Investor
“I have to say that experience plays a big role. ”
Definitely! I only got started a couple years ago, and I am learning a lot.
@Andrew
I’m glad that I discovered your site; I’ve learned a lot by engaging in these discussions with intelligent fellow bloggers, and also by reading your posts. Great stuff!
Andrew Hallam says:
June 3, 2010 at 7:47 am (UTC 8 )
Thanks Kevin,
I’m actually really really happy with the thread contributions; I’m so darn impressed by how intelligent the comments are. Thanks for that. Guys like you have definitely added to the quality of my blog.
I agree with you about index funds. It’s funny. So many people believe they can beat diversified baskets of indexes, but statistically, they don’t–and they won’t.
As I’ve mentioned to you before, I’m getting closer and closer to a fully indexed concept myself. Like most people, I started out in mutual funds (in 1990) migrated to common stocks, but slowly, those are being trasncended by indexes. I don’t have a U.S. or Canadian equity index yet, but my bond money is all in XSB.TO and my international equity money is all in VEA.
Andrew Hallam says:
June 3, 2010 at 7:50 am (UTC 8 )
@Monevator
Monevator:
It’s my pleasure. Your writing is superb and I really enjoy your blog.
As for investors fearing volatility, my thought is that investors should have a really good course in financial history that they teach themselves before investing a penny in the markets.
Financial Cents says:
June 9, 2010 at 11:13 pm (UTC 8 )
Enjoy Andrew and fellow readers
Canadian mutual funds lag index, again:
http://www.theglobeandmail.com/globe-investor/markets/markets-blog/canadian-mutual-funds-lag-index-again/article1597581/
Andrew Hallam says:
June 10, 2010 at 11:45 am (UTC 8 )
Financial Cents:
I love it! It’s super that they take into account survivorship bias in this assessment. It sure makes the argument for passive investing pretty solid, doesn’t it?
I’d love to see the same assessment/comparison done in a taxable account, after taxes. It adds at least a further 1% advantage, compared to the active approach.
Thanks for sharing this link!
Andrew
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The Joy (And Folly) of Emotions | Invest It Wisely says:
June 4, 2010 at 11:23 pm (UTC 8 )
[...] was recently interested in this due to a very interesting conversation I had at Andrew Hallam’s blog about how emotions taken to excess can be the downfall of investors, and how otherwise very smart people can make what seems like bone-headed mistakes, due to being [...]