Grow recently asked me to write about the pitfalls of trading money in and out of investment accounts. Trying to time the market is a bad idea, folks. Really, nobody can do it. If you think you have, you’ve just been lucky or had insider training. You are sure to be a victim of one of my favorite behavioral concepts, accidental reinforcement*. What’s that? Click, or read below. Anyway, here’s an excerpt of my Grow story. You can read the rest on their site.
It’s called “high-frequency monitoring.” And we’ve all been guilty of it. After all, studies show Americans look at their cell phones 150 times a day. Who can resist checking in on their investments once or twice or…50 times during a day?
It’s tempting, but it’s also a terrible idea. High frequency monitoring (obsessing?) inevitably leads to high(er) frequency trading, which we know is a bad idea. How do we know? Study after study has shown that people who move money in and out of investments fare worse than those who don’t. Here’s one which found that men trade 45% more frequently than women, and as a result, earn 2.65% less annually in returns.
Not only is trading in and out of stocks a form of attempted market timing — generally a recipe for disaster — but it can also result in unwanted capital gains taxes. (Not to mention penalties, if the money is saved in a tax-advantaged account like a 401(k) account). Most of all, it means your cash will be sitting on the sidelines at a time when the market might be ready for a rally.
Nevertheless, on days when the market is in a foul mood, it can be awfully tempting to so something drastic and sell on the bad news.
That’s usually a sucker’s bet. Professional traders call it “locking in losses” — you only actually lose money when you sell your investment. Until then, the losses are on paper only.
Let me show you how ill-timed twitchiness can really cost you.
Let’s say you had about $2,100 invested in an index fund last June when the British Brexit vote smacked investors right in the face. The value of your investment quickly dropped to about $2,000 by market close June 27. Say you pulled the rip cord and sold. You would have missed out on the market recovery, which took all of…four days. You would have lost about 5 percent of your money.
Now, say you stayed on the sidelines, disgusted by it all. Today, that $2,000 should be worth about $2,350, but yours would be worth….$2,000. You would have missed out on a full 17 percent gain.
Or let’s say you had jumped back in during the summer, but the U.S. election gave you cold feet. So you sold on Nov. 4, when your money would be worth about $2,085. If so, you would have missed out on $300 in gains — about 15 percent — just by missing the four-month post-election rally.
I have more math at Grow with an example of small annual withdrawals costing an investor one-third his/her savings. But let me also make this important point: Selling individual investments, but keeping the cash in your retirement account, is a perfectly logical thing to do, especially right now. That’s very different from selling and using the money.
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