WASHINGTON, March 6 (Reuters) - The Dow Jones Industrial Average rallied to a record high on Tuesday, and if you are anything like the typical investor, that made you want to race out and buy stocks.
That is the typical and self-destructive buy-high, sell-low pattern of individual investors. “When the markets are doing well, people are much more interested,” said Charles Rotblut of the American Association of Individual Investors. “There’s a definite correlation between the market rising and people investing, and the market falling and people selling.”
Mom and pop did start to put money into the stock market in January and February, when the Dow rose 7.2 percent, according to data from Lipper, a Thomson Reuters (TRI.TO> company, and the Investment Company Institute, a mutual fund industry trade group.
But before then, individual investors spend the better part of the last four years staying away from stocks, after being spooked by the 2008 credit crisis and subsequent stocks selloff.
From June 2008 through December 2012, investors pulled $399 billion from stock mutual funds, with most months showing net withdrawals, Lipper reported.
This fear-sell, greed-buy cycle really hurts the nest eggs of the people who are stuck in it. Investment research firm Morningstar has analyzed how individual buy/sell decisions affect returns and the results are disturbing.
Over the last 10 years (through Jan. 31), U.S. stock mutual funds reported total returns of 8.77 percent a year. But individuals in those funds actually earned 7.76 percent a year because they bought and sold at the wrong time.
Put another way, if you started with $50,000 and let it ride, you’d end the decade with $120,171. If, instead, you matched the typical fund investor’s trading patterns, you’d end up with $108,629, or $11,542 less.
“That’s not because people are picking bad funds,” said Morningstar’s vice president of research, John Rekenthaler. “It’s because people lack discipline when it comes to asset allocation.”
The spread between individual returns and regular fund returns was even bigger for other asset classes: Commodity funds returned 6.37 percent annually over 10 years, but investors in those funds earned only 3.58 percent a year.
All funds earned 7.54 percent a year during that 10-year period, while individual investors earned 6.12 percent, cutting their returns by 19 percent via bad buy and sell decisions.
But it’s not yet time to run for cover. With a lot of money still on the sidelines and in bonds, and with many analysts saying they still haven’t seen the exuberance (rational or otherwise) that typically marks a market top, you probably still have some time to make rewarding stock purchases. “This may be a jumping point to ever higher numbers,” said Jeff Tjornehoj of Lipper.
Here’s how to grab the momentum without getting carried away by it:
* Stick to your plan. Figure out what portion of your long-term nest egg should be in the stock market, based on your time horizon and risk tolerance. Then put it there and keep it there, says Tjornehoj.
* Consider valuations. The Dow and other market indexes still are not expensive by historic measures. On Tuesday, it traded at roughly 15.87 times expected 12-month earnings, compared with 16.99 during the 2007 highs, according to Thomson Reuters Datastream.
* Don’t be shocked or scared away by a reversal. “We view a 3 percent to 5 percent pullback likely in the near term,” said Brad Sorensen, director of market and sector analysis for Charles Schwab Corp. That could present a buying opportunity for the aforementioned folks underinvested in stocks.
* Cherry pick. The higher prices go, the better it is to focus on specific stocks and sectors that still may be the most rewarding. For example, the Dow represents old-line dividend-paying behemoths, many of which were considered the safest stocks to buy during the fear years. The Nasdaq, by comparison, is driven by technology stocks that still have not surpassed previous highs and may hold more promise, according to some analysts. “We continue to like tech due to attractive valuations and companies loosening their purse strings as they become increasingly confident in the economic recovery and willing to invest in efficiency enhancing tech,” said Sorensen.
* Don’t assume your adviser will protect you. Since the credit/market crisis of 2008, many financial advisers have been following their clients instead of leading them. As worried investors called, their brokers and fee-only advisers channeled them to bonds and fixed annuities and other “safe” investments to calm those fears. The Morningstar research that looks at how funds perform versus how investors in them do? “Nothing we’ve seen suggests that there is a difference between the adviser-sold funds and the direct retail funds,” said Rekenthaler.
* Remember that discipline. Maybe, as Rekenthaler believes, the end of this bull is still two or three years into the future. When that happens, bear in mind that the people who were really making money today were buying in 2009, when the proverbial blood was on the street. As Tjornehoj put it, “It would have been better to get in three years ago.”