Meet Carol

When I go to cocktail parties and people learn what I do, they ask me if I have any idea where the market is headed. I typically answer “no” and they look at me like I’m some kind of weirdo.

Hey, I can guess as good as the next person but that’s not the point. It’s simply that I think it’s irresponsible to promote this fallacy that that’s what professional investors think about and that being good at that kind of guessing is a skill needed for investing. I don’t believe in guessing where the market’s headed. Nobody knows. It doesn’t matter.

Meet Carol. Carol’s a doctor. The first thing you notice about her is that she’s really tall and, unlike some really tall women, she wears seriously high heels. We’ve met at her office intending to head to the hospital cafeteria for lunch. I struggle to keep up as she strides along the corridors and I don’t know, maybe it’s the lab coat or the stethoscope around her neck, but there’s something about her that tells people she’s in charge and really smart.

Today she’s wants me to know that she’s decided that she needs to pay more attention to her portfolio. Now, if you’ve gotten this far, you know I’m just adamant that you pay attention to your portfolio so I initially applaud her decision. However, it turns out that her version of paying more attention was about to drive both of us crazy.

Here’s why. Carol’s version involves her correctly guessing when the market is going up and when it’s going down. She thinks she can move in and out of stocks virtually guaranteeing that she’ll do better than I will using an approach that ignores market guesses.

You see, I’ve been managing her money for years and she’s done quite well relative to the market. Of course, she lost money last winter and hindsight is calling her. “I could just kick myself for not being more involved. I would’ve done better if I’d been paying more attention’” she says. I’m thinking to myself, okay, I have been paying attention and we’ve done damn well if I do say so myself.

This idea that she can predict the market has been brewing for some time. Last winter in the thick of the downturn and just days before the presidential election she said, “I’m frightened the market will just keep falling and I want to pull out. But I don’t want to do it before the election because I think it will go up when Obama is elected. What do you think?”

“Well Carol, as I’ve said many times before, I have no idea what the market will do and more importantly, I wouldn’t make market predictions the driver of your investment decision making.” Look, I wasn’t taking a position regarding whether Carol should pull her money out, just that doing it or not shouldn’t depend on a naïve belief that she had some special insight into market predicting.

“But, just for the heck of it,” I say, “if I were a betting woman I’d guess that the market will fall when Obama is elected. It’s pretty clear that the outcome of the election will be in Obama’s favor so that fact is already priced into the market. In fact, the market has rallied for the past three weeks and I’m guessing a good part of that is anticipation of his victory.”

“Well,” she says, “I’m going to hang in there because I think it will go up.” And she did.

And then, guess what happened? Obama won the election and the market began a steep decline on Election Day and it continued for several weeks thereafter. Carol, who before the election was evidently feeling as though she couldn’t tolerate the volatility, didn’t listen to what mattered, her risk tolerance, and instead ignored that in favor of the siren call of market prognostication.

What should Carol have done differently? First and foremost, she should get over this idea that it’s all about guessing where the market is headed. I know this is heady stuff driven by media who’ve realized that it’s the sexy part of investing, talking about market swoons and peaks. You know, it’s like human catnip. People get sucked into thinking they’re smarter than everybody and while they acknowledge the statistics that show that no one can fruitfully predict the market, they nonetheless can’t stop themselves from trying it again and again.

Since then, Carol and I have gone many rounds. Rewind and replay: Carol ruminates out loud about where the market is headed, asks what I think about where the market is headed and then what I think we should do about it. I respond each time that I have no idea where the market is headed and think we should keep on keeping on. I explain that the best use of my time is instead paying attention to owning the right investments and constructing the best possible portfolio while letting go of things I can’t control. Yes, her portfolio will go up and down as the markets do the same, but if I can make a portfolio that goes up more than the market and down less then we’ve won.

This spring, Carol opened a new IRA Rollover account and moved several hundred thousand dollars into it. “Don’t invest that money just yet” she says, “I think there’s going to be a major market collapse soon. In fact, I’m going to send you a newsletter that predicts the market will crash in the fall. Have you heard of this guy? What do you think?”

Silently, I think “here we go” and we repeat our well-worn dialogue yet again. This time, Carol keeps her new money out of the market and the market goes up over 50% in the days in the ensuing days and months. Carol’s return for that same period was in the low 30% range as the added cash was a counterweight to the stellar returns posted by her stocks. In normal times, a portfolio rising 30% in several months is not bad at all. This time however the strong move upward was preceded by an equally strong move downward. She needed to earn all 50% to make up for what she’d lost.

In each instance of market timing, she zigged when she should have zagged. And that’s exactly the reason why market timing doesn’t work. I don’t say she failed because her guesses were perfectly ill-timed, I’m saying she never should have fallen into the market timing trap in the first place. She needed to do what I’ll teach you to do and that is to develop your own tolerable range of stock holdings and then to stick with that range as markets go up and down. Had she stayed the course in each instance, her returns this year would have outpaced her losses last year.

Now it’s September and we’re having lunch. The last item on her list is that she has some new money to invest. She thinks she knows what I’m going to say but asks what I think about this guy and his prediction of a major market downturn. She mentions that he’s been right before and wants to know if I think there’s something to his prediction this time. Carol asks, “Do you think I should keep this new money safe until the market falls again, and then I’ll put the money to work after that happens?”

“Carol I don’t know why you think you can make more money or lose less by guessing where the market is headed.” “I know,” she says “they say you can’t predict markets.”

“Carol, what do you mean ‘they say?’ I’m not talking about some abstract statistic here, I’m talking about the fact that you’ve taken several runs at predicting it and each time you’ve been wrong, leaving a substantial percentage of return on the table. What’s with that?”

“Yeah,” she says, “maybe you’re right. But, what do you think I should do?” Uggh.

Carol and I part and I expect we’ll have these discussions for so long as markets remain volatile. A period of slow steady gains will be needed to allay Carol’s desire to play the prediction game. She’s not alone.

Think about it. How many times have you tried and been wrong? Most investors who move in and out focus solely on one side of the investing equation. They pay attention only to pulling out before markets tumble and little to putting it back in before markets take off. I read recently of a study of women’s behavior toward continued use of beauty and weight loss products. When women perceive a product is not working, they continue to use it. The researchers attributed this to the fact that when you think something isn’t working, you simply need to keep at it longer. I’m guessing that whatever it is, the phenomenon applies to market timing because now more than ever investors are trying it, failing and trying it again with increasing fervor at every turn.

And they’ve got plenty of folks feeding their frenzy. Any guru can make a name for himself predicting the market will fall. If he persists in his prediction long enough, he’ll eventually be right. The market will fall. Markets rise and fall; that’s their nature. If the market falls close in time to when he made the prediction, then he’s a genius and will attract many followers who will cite that he predicted this and such market collapse. No one pays attention to the fact that he never says when to put money back into the market.

Professional long-term investors know that investing well has nothing to do with either and plenty to do with much more mundane things. The good news is that the things important to investing well are all things any woman would know. Investing well involves following steps, mixing in the right ingredients, in the right portions and in the right order.

Those of my clients that stayed invested in their unique mix of stocks and bonds fared better than those that jumped in and out. With clients that maintained their overall strategy we were able to use defensive techniques such as buying in equal proportions and rebalancing all of which get little press but which I promise will help you lose less and gain more. And these techniques are all built into my system. You’ll be using them without even knowing it. I’ll teach you.