Why We Buy in a Marked-Up Market; Investors need to overcome the instincts that lead them to buy and sell stocks at precisely the wrong times

Why We Buy in a Marked-Up Market

By CARL RICHARDSJAN. 13, 2014

When dividends are included, 2013 was the fifth consecutive year of positive performance in the stock market (as measured by the annualized Standard & Poor’s 500 return). The stock market is now up more than 200 percent from the bottom of the financial crisis in March 2009. Returns since those dark days have been unbelievable, including the market’s most recent performance in 2013 of around 30 percent.At the same time, however, the numbers also show that we have lost our appetite for stocks. According to the research firm Lipper, from 2006 to 2012 we withdrew more than $450 billion from United States stock funds. Then, in 2013, someone flipped a switch, and we decided we liked stocks again. Through the middle of December 2013, $60 billion was added to United States stock funds.

Think about this switch for a second. When the entire stock market had a huge 50 percent-off sale in 2009, no one wanted to buy. Now that the market is marked up 200 percent, we feel that it is time to get aggressive again.

A technology sales manager was recently quoted in a recent article in The Wall Street Journal: “Frankly, from 2009 until recently, I wanted to stay very conservative,” he said. Now, “I want to get more aggressive.”

Now? More aggressive? Why weren’t people more aggressive when stocks were on sale?

A friend recently shared a story about his brother that illustrates this reality perfectly. You would assume that as a supersmart engineer, my friend’s brother usually thinks rationally. But in 2009, he stopped adding to his 401(k). He considered it a waste of money. He has just started contributing again, but completely missed the huge rally.

Ultimately, it comes down to fear. People are worried about missing any more of the market’s gains. As a result, for example, they change their 401(k) allocations to be more aggressive (that is, invest in more stocks).

Do we behave like this with anything else?

Imagine walking into a car dealership, and the sales representative greets you with: “It’s your lucky day! The car you want is now twice as expensive as it was yesterday.” You get excited and say: “Great! I’ll take two of them!”

Stocks and other investments are the only things we rush to buy after they are marked up and hurry to return when they are on sale. We don’t care that we are losing money. Just take it back! We want out!

I know why we do it — we feel as if we have to. If feels like a matter of survival. We’re hard-wired to pursue the things that give us pleasure or security, but get away as fast as possible from things that cause us pain. When the stock market holds a once-in-a-decade sale, it’s scary. The news is scary. Your neighbors are scared, and then we get scared.

We think the only way to stop the pain is to get out. Then, after swearing we will never invest in the stock market again, we watch it rally for a few years beyond old highs. We start hearing the news. Our neighbors start bragging about their returns, and before we know it, we are adding stock symbols to our iPhones and buying stocks again.

We have fallen prey to a cycle as old as trading itself. We buy high, sell low, and now we’re positioned to buy high again.

So while there is some discussion that we are getting better at long-term thinking, the market inflows and outflows, as well as the stories in my inbox, don’t show it. In fact, if CNBC can be trusted, the average hold time for the most widely held S.&P. 500-stock index exchange-traded fund, the SPDR S.&P. 500 fund (SPY) declined to less than five days in 2012. Sure, this average hold time is driven down by the amount of high-frequency trading that takes place using SPY. Even so, that number still shocks, given how widely SPY is used as a core holding by many do-it-yourself investors.

Speaking of hold times: The economics writer Nate Silver points out in The Signal and the Noise that people held stocks for an average of 6.3 years in the ‘50s. Hold times declined every decade until the 2000s, when they held steady at around six months on average.

We are doing the very things — buying high/selling low, turning over quickly, reacting to the news — that evidence shows does not help us to be better investors. Why? Investment success is not a matter of more information, intelligence or skill. It’s a matter of behavior.

By recognizing that success is about behavior and not something else, we can start building in the corrective measures that will help us avoid mistakes in the future. We can put emotional guardrails in place to help us avoid behavior that keeps us from reaching our financial goals.

Once we accept that buying high and selling low is our natural tendency, then, and only then, can we start to fix it.