Investing is Simple, Isn't it?
A common misperception about investing is that it’s easy because all you have to do to profit is buy low and sell high. And it’s true that buying low and selling high will earn you a return on your investment. In reality, buying low and selling higher is much easier said than done. Investors that buy low and sell high are the exception to the rule (and investors are typically smart people!)Â
A wise investor (Benjamin Graham) once said: “An investor’s chief problem – and even his worst enemy – is likely to be himself.”Â
What is Buying Low and Selling High?
The strategy “buy low, sell high” is where you buy a stock when its price is low and sell it later at a higher price. Buying low and selling high sounds simple, right? It is! However, as Warren Buffet would say, “investing is simple, but not easy.”
In practice, identifying lows and highs is extremely difficult. Indeed, timing the market is a fool’s game.
The field of study known as “Behavioral Finance” argues that people often make investment decisions based on emotions and biases. Investors are people, and people tend to be more irrational than rational.
Why is it Hard to Buy Lows?
Psychology works against you. It’s easy to sit here now and say that you will buy at lows, but when the market tanks and your portfolio is red across the board, you will have doubts. You will feel uncomfortable. You will wonder if the smart thing to do is to cut your losses now. It’s hard to double down and put more into something that is not performing. Our survival tendency is flight.Â
Besides the psychological aspect, there is also the liquidity aspect. If your money is actively at work (tied up in investments), you don’t inevitably have extra cash laying around when lows hit. But it’s better to have your cash at work around the clock rather than sitting on unproductive cash and trying to time the market. The lost time will ultimately end up costing you more.Â
If the economy is going into recession and you are worried you may lose your job, it’s unlikely you will start taking risks on a falling market (ever try to catch a falling knife?). You will need enough cash in your savings nest egg to weather the storm and may even consider pulling money out of the market.
Why is it Hard to Sell at Highs?
On the other hand – when things are going well economically, when you have job security and extra disposable income to invest, buying into the stock market then likely means buying at highs.Â
It’s also challenging to call a high due to psychological aspects. When you own a stock that is performing well, you want it to keep performing well. You want to keep holding it, not sell it.
What Drives Stock Market Prices?
Always remember that the two things that drive the market are: greed and fear. And unless you are a computer, you are not immune to falling into the traps of greed and fear. Fear prevents an investor from buying low, and greed stops an investor from selling at highs.
Can You Beat the Stock Market?
Good investors need to be contrarian. Moving with the herd will have you buying at highs and selling at lows. You may have the impulse to do what others are doing because you believe others may have access to more or better information. And as a retail investor, you can guarantee institutional investors have more and better information. It is hard to be contrarian, but it pays off. When you’re right, and everyone else is wrong, the payoff can be huge.Â