Wednesday, September 5, 2018

We Are Tempted to Follow the Crowd

Bubbles happen in the markets because everyone is doing the same thing and it also happens to be the worst possible thing they could be doing at the time.  The common thread through bubbles is greed, whether that greed is institutional or individual. The dot-com bubble happened because everyone thought the Nasdaq run would never end, while tech start-ups were burning cash like it was so much refuse. The reality check came with a thud. The housing bubble happened because people were cajoled into thinking their homes could only go up in value ー and that, too, ended with an economy-shocking and recession-inducing thud.

Where are the masses rushing to next? Risky income-producing investments? Take your guess. One thing you can be sure of is that human nature will not change: people will follow other people , and the majority will get burned. It is good to seek some contrarian advice now and then. We are emotionally driven creatures, and the recent findings in behavioral finance demonstrate that these emotions fool us and lead into poor financial decisions most of the time.

As with most things in life, you get what you pay for. That I can buy a stock for only $7 does not mean I am going to profit from that purchase. In fact, because it is so easy and inexpensive to buy in and out of that stock, the odds are increased that I will act on impulse and trade in and out at the wrong times. More important than the cost of making an investment is the quality of that investment. You can easily go broke in a short time at $7 a trade. I am reminded of a great Warren Buffett quip: "With enough insider information and a million dollars, you can go broke in a year."

Individual Investors Underperform (click here)

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