1/20/08

If You Must Time the Market, Buy Only When Fear Takes Hold

Repeated so many times it's become a cliche, I'm sure you heard this one of Warren Buffet's famous aphorisms: be fearful when others are greedy and greedy only when others are fearful.

It makes a lot of sense. That's how you buy stocks, and anything really, on the cheap.

So why don't people do it? Why do the majority of retail investors lose money on the stock market?


Small individual investors are fearful when times are bad, or are about to be bad--during a recession or when it seems there will be one. At such uncertain times, when you don't know how long your job will last, when there are no other job prospects in sight, and when the cost of your daily living goes steadily up all the while what stock holdings you've been able to amass plummet, it's hard not to be fearful. Putting money away for emergency use becomes much more important. Investing, if not a faraway thought, seems imprudent at such times. And rightly so.



For those with money to spare, however, fortunes can be made. All sorts of assets get cheaper, from stocks to land. They will eventually go up; history shows us this. For example, the Dow Jones Industrial Average nearly quadrupled from mid 1932 to 1937, after the great crash. Following every market downturn, stocks have broken even and then gone higher. Buying near the bottom, when others were fearful, has always paid off quite well.



It may come as no surprise that small individual investors rarely come out ahead after a market and economic downturn. Part of it is because of what's mentioned above--the fear. Part of it, however, comes from not following the other side of Buffet's advice: being fearful when others are greedy; and it is being greedy when others are greedy that causes the fear. For instance, it is somewhat common knowledge that an easy way to determine when the market has reached its peak is when individual investors enter the market. This is when one should become fearful.



It is said that that John F. Kennedy's father sold all his stocks before the great crash because he overheard shoeshine boys discussing stocks. From my own experience, when I was a wee lad during the height of the late 1990s internet bubble, one of my dad's acquaintances, a regular Joe, started talking about buying stocks, emphatically saying, "we have to buy those things--you know, those papers--stocks!" At the same time, the talking heads on CNBC were screaming that there was no top in sight. If you were watching CNBC in October when the DJIA reached its record high, you might remember the talking heads screaming that that was the bottom, and the sky's the limit. That's when you should cash out.



When should you start buying? When your uncle Charlie's lamenting about his stock market losses starts getting on your nerves, the screamers on TV are quiet and gray faced, and politicians have been talking about stimulus packages for a while. That's it. Don't buy at any other time. Save the money you would have used to buy stocks at their highs in an interest bearing account. Be patient. So you'll feel a little left out when the TV screamers are jolly, but you'll have money to spare when things are cheap.



Will you do it? No. Will I? No.

The temptation to buy when things are good is too great.