Know Your History

History provides some great insights into investor behavior. Since 1914, most individuals and institutions tend to buy stocks after Wall Street gives them the green light. This usually happens after stocks have already risen substantially. If the stocks they recommended fall, Wall Street tells customers to hang on...after they’ve bottomed, analysts aren’t recommending them anymore. As a result, investors wind up buying high and selling low because the “experts” say to. Clearly this is not the making of a solid investment framework.

Unfortunately, to buy low and sell high is more difficult than most people think. We are, in many ways, wired for poor investment results. When the markets are declining and our portfolios are losing ground we naturally want to stop the bleeding, often times selling only after major declines. Alternatively, when the markets seem to be breaking new highs everyday (think late 90s), investors feel like they are missing out and end up rushing into stocks at prices well above what any rational being might be willing to pay. In the end, this emotional rollercoaster leads investors down a road that will inevitably lead to sub par long-term performance.

Putting an End to the Emotional Train Wreck

While there are seemingly endless investment methodologies (evidenced by the thousands of mutual and hedge funds pitching unique strategies), from our perspective, investors have two options when it comes to controlling emotions in the management of their portfolios.

1. The “Markets are Efficient” Approach:
The approach goes something like this; Since markets tend to be efficient over time (i.e. there is no advantage to active investing), the best stock market investors can do is to invest in a diversified portfolio (to manage individual stock risk such as bankruptcies, fraud, etc...) of stocks, periodically dollar cost averaging their holdings, and over time the portfolio should more or less mimic the broad markets returns. No need to worry, not sleep at night or freak out when the market goes down 100s of points in one session. Just focus on the very long run and you should do about average.

2. The “Active Value Investor” Approach
This method still relies on investing for the long-term as we tend to agree with the efficient market crowd that in the short run markets are efficient and it is therefore quite difficult to time your investments accordingly. However, we do believe that the stock market will always offer opportunities to the diligent bargain hunter. Over time, if you buy securities selling at a meaningful discount to your estimate of their true value, then you should experience outsized returns relative to broad market averages. Patience is important however. Value-oriented bargain hunters won’toutperform the averages every year (many underperformed during the late 90s technology bubble), however over the long run, and with some effort, they should do well above average on their stock investments.

 
Recommended Reading for the Active Value Investor

The Intelligent Investor, by Benjamin Graham.
Considered the grandfather of value investing, Ben Graham was a mentor to Warren Buffet, WalterSchloss and other high profile (and highly successful) investors.The book offers invaluable insights into the intellectual and emotional framework required to become a successful value investor.

About American Money Management, LLC

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Disclaimer
The opinions expressed are those of Gabriel Wisdom and Michael Moore and do not necessarily reflect the opinions of American Money Management, LLC (AMM), an SEC registered investment advisor. Clients of AMM, Mr. Wisdom, Mr. Moore and employees of AMM may buy or sell investments mentioned without prior notice. This newsletter should not be considered investment advice. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything.