Many investors purchase or sell securities at precisely the wrong time. Specifically, they buy high and sell low! We believe that part of the reason behind these untimely transactions has to do with the rational expectation that one should accentuate the positives and reduce or eliminate the negatives in life. Unfortunately, many times this does not work when investing money. Let’s take a look at a couple of examples how this natural reaction works against you when investing.
We have many clients who own common stock in Ford Motor. Ford has recently been trading at approximately $14.50 per share, twenty-five percent below its fifty-two week high of $19.00 set within the past twelve months. In our opinion, the stock has been weighed down by a number of factors, not the least of which being the slowdown in the economy as well as the tragedy in Japan. This drop in value has generated several telephone calls from individuals who think that Ford Motor may be a timely buy at these levels. To bolster their case, they justifiably cite many reasons why business should remain strong for Ford, including their long-term global business outlook. The question as to whether or not Ford is a good buy, in part because the share price has dropped is an appropriate manner of investing. One may believe that the price has fallen to a point that more buyers than sellers will step in and, given the current economic environment, the share price will begin to rise. Conversely, we are also receiving contacts from individuals who are concerned that the recent decline in share price is not yet over and are deciding whether or not to unload their shares. They believe that the uncertainty surrounding the issues noted above will continue to weigh down the stock. Only time will tell which investor has made the correct decision, the one who perhaps buys shares at this time or the one who sells. However, both are making decision based upon the share price fluctuation and many times, this is a mistake. Just because a stock you buy goes up, it does not mean you made a wise investment and conversely, just because a stock declines after your purchase, it does not mean you have made an unwise
decision. We suggest that investors make informed decisions based upon the fundamental outlook for the company, the industry it operates in and the macroeconomic outlook both domestically and, the case of Ford Motor, globally.
Our second situation pertains to the individual who contacted us during 2010 and wished to
purchase shares of Ford Motor because it had moved from ten for fourteen dollars per share. Or the individual who wishes to purchase shares because his neighbor has made a ton of money with Ford or the individual who won’t sell his or her shares because “Ford has been good to me over the years.” All of these situations may be accurate, but it does not answer the prevailing question when deciding whether or not to make an investment. That is, what is the potential for the stock price to appreciate? Again, to answer these questions, one must once again look at the fundamental data surrounding business conditions for Ford Motor.
In our opinion, the change in the share price over a period of time is not nearly enough of a reason to purchase or sell the security. You purchase a stock because you believe it has potential. You sell when you believe there is a lack of potential or to move on to a company with more potential.
The potential for an investor to buy high and sell low is clearer when analyzing cash flows into mutual funds. Mutual funds experience their greatest net inflows after having beaten their peers on a total return basis over a given time frame. However, many of these same investors are buying high only to experience pain as those investments that made the mutual fund successful correct back down to a reasonable price. For example, the emerging market funds during the year 2010.
Finally, cash outflows from bond-based mutual funds are at their greatest after interest rates rise. This occurs because the trailing returns are subdued by the inverse relationship between bond prices and interest rates (as interest rates go up, the value of bonds decline and visa versa). However, poor returns on bond funds are usually an indicator that the bond fund will perform better in the future. This is once again due to the inverse relationship described above. Therefore, generally speaking you should sell bond funds after a period of good performance and buy bond funds after a period of underperformance.
We revert back to our initial observation that when investing, it is often prudent to accentuate the negative and reduce the positives. This translates into buying low and selling high.