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The Science Behind Buying High & Selling Low

Gary D. Halbert
September 25, 2007


1.   The Mutual Fund Merry Go-Round

2.   The Dalbar Studies

3.   Some Interesting Statistics On Emotions

4.   “Neuroeconomics” To The Rescue?

5.   Is Your Risk Tolerance What You Think It Is?

6.   Putting Professionals On Your Team


Who can argue that the stock markets have been trading on emotion for the last couple of months?  It seems that with every news story about the economy, or the subprime mortgage problem, or what the Fed might do, the market either goes up drastically or takes a steep dive.  I haven’t seen market action so closely tied to the news media since the uncertainty surrounding the presidential election in November and December of 2000.

Just for the record, market moves in the 2% range are not all that common, especially since the bursting of the tech bubble in 2000 and 2001.  I recall reading an article dated November 22, 2006 that stated it had been 917 days since there was a 2% down move in the S&P 500 Index.  However, it was not until early in 2007 that the author got his wish for a 2%-plus down move.  On February 27, the S&P 500 Index declined -3.47%, followed by a -2.04% decline on March 13.  You may recall that this period of time included a sell-off in China as well as the first subprime scare. 

Even more unsettling, however, are recent 2% market moves in both directions, sometimes on consecutive trading days.  No trend line will give you this kind of market action – it’s pure emotion.

Those of you who have been reading my E-Letter for a while will know that I have often written about the dangers of investment decisions based on emotion.  Over the years, I have discussed studies that quantify the risks of emotional trading, and even how some investment marketing tactics actually seek to prey upon the emotions of fear and greed.  The fact is that your emotions are actually your worst enemy in investing, and there’s an ever-increasing body of proof to back up this statement, as I will discuss in more detail below. 

With several hundred thousand new readers, I will use this week’s E-Letter to revisit how our emotions can negatively affect our investment results, including some interesting statistics I ran across recently.  I’ll also discuss some ideas on how to take the emotions out of your investment decisions.  We can all use some help with that!

The Mutual Fund Merry Go-Round

I subscribe to a lot of investment and business related magazines and periodicals, plus I watch the financial shows on cable TV.  Frequently, these sources report the latest mutual fund performance results for the prior month or quarter or year, and they “slice and dice” the funds’ performance in various and different ways (best, worst, etc.). And they also make recommendations on which funds you should invest in now.

You see the frequent headlines: “Which Funds To Own Now,” “Top 10 Mutual Funds,” and on and on.  The newsstands are full of magazines like this, especially each January, and the cable programs regularly trot out panels of so-called “experts” with their advice on which funds (or stocks) you should buy now.

The problem is, almost all of them recommend that you invest in DIFFERENT FUNDS every year or every quarter and some even more frequently.  Yet at the same time, they tell us we should be “long-term investors.”  How can anyone be a long-term investor when we are advised every year, every quarter and even every month to invest in the latest hot performing funds? 

Because there are so many mutual funds (over 15,000 in the US alone), the top performing funds are rarely ever the same in any given consecutive time periods.  Many investors end up switching from fund to fund to fund throughout the year as a result of all the conflicting advice.  I call it the Mutual Fund MERRY GO-ROUND!

Even worse, these publications and programs rarely analyze how you would have done if you followed their previous advice.  The reason for this is simple: they don’t have toSince these publications don’t sell securities, they don’t have to register with the regulatory agencies, and as a result, they are not required to give specific past performance information.  So they usually don’t.  Basically, it’s buyer beware.

Chasing The “Hot” Funds

Many investors are on the Mutual Fund Merry Go-Round.  They buy and sell their mutual funds (or stocks) frequently, often several times a year, and usually, because they get so much conflicting advice in the media and elsewhere, they are continually chasing the latest “hot funds.”

The problem with chasing the latest hot funds is that they can go cold – or lose money – just as quickly as they got hot.  Many investors buy the latest hot funds only to see them under-perform or lose money.

Sometimes funds are the victims of their own success.  Being one of the “hot” funds attracts a lot of investor money.  Some funds grow so large that the manager and/or the strategy can’t continue to produce the big returns, and may even lose money.  There are several other reasons why hot funds can go cold in the future, but the bottom line is that you should never invest in any mutual fund just because it was the best performer over the last year.

The Dalbar Studies

One of the first studies I encountered documenting the negative effects of investor emotions on performance was conducted by Dalbar, Inc., a market research firm in Boston.  The study came out in 1995, and showed that mutual fund investors, on average, were not receiving anywhere near the performance published by the mutual funds themselves, largely because of frequent switching in an effort to chase the “hot” fund performers.

Let me explain.  If you bought and held a mutual fund for five years (with no additions or withdrawals in the account), then you would make exactly what the fund made over that period.  If it made 50% over that period, and you held it the whole time, then you would make 50%.  But many investors don’t buy and hold a fund for long periods of time.  Instead, they jump out of a fund when losses occur, and invest in another “hot” performing fund.  The end result is that they often buy high and sell low.

When I first wrote about this in my monthly client newsletter, I assumed my clients would be immune from such emotional trading.  However, just the opposite was true.  I got an overwhelming response from clients who wanted me to help guide them to professional money managers who could assume the management duties of their investments, and thus our AdvisorLink® Program was born.

What became so compelling to my readers was Dalbar’s statistical analysis of mutual fund money flows that showed what the average stock and bond mutual funds made (performance) versus what the average investor in those same funds made.  The results are surprising

To illustrate, I will summarize Dalbar’s 2007 update to their Quantitative Analysis of Investor Behavior (QAIB) study.  This most recent update found that most investors make investment mistakes during downturns in the market, because “investors are driven by fear that the markets will not recover.”

The tendency to redeem an investment during periods of losses and either buy another “hot” fund, or stay out of the market entirely, is what leads to poor investment performance.  In the 2007 update, Dalbar showed that a systematic, buy-and-hold investment approach led to a 40% greater gain than if investments were patterned after the average mutual fund investor’s behavior.

The problem is, most investors jumped around from fund to fund during that period, often buying high and selling low.  Yes, the investors who bought the average stock fund(s) and/or bond fund(s), and held them for that entire period, made roughly what the market indexes made.  But the results of the Dalbar study indicate that many investors didn’t do that.  Due to bad timing, they didn’t make nearly as much as the average mutual funds.  

Lousy Timing

I was shocked when I first began to look at Dalbar’s (and others’) numbers on this in the early 1990s!  I had no idea that so many investors, as a group, were jumping from fund to fund to fund so frequently, and with such disastrous results. 

My observation in dealing with thousands of investors over the last 30 years is that most people do NOT have good timing when it comes to the markets.  We have a tendency to buy things when they are hot, not when they are cold.  In many cases, it should be the other way around.  While the media is certainly a willing accomplice along this line, we are all influenced by greed and fear, at least to some extent.  In other words, we sometimes let our emotions rule our investment decisions.

Let’s face it, most people are not professional investors.  For example, I have thousands of investment clients all across America.  Many are actually “accredited investors,” generally meaning that they have a net worth of at least $1,000,000.  In all these years, I don’t remember a single client telling me that they made most of their wealth from their investments.  No, in most cases, they became wealthy as a result of their primary business or occupation or a large inheritance.

If you have a successful business, you know that it took a lot of hard work, a lot of experience and a lot of good decisions.  Investing successfully is no different!  I have never understood how prosperous businessmen and women think they can be successful investors right off the bat, without hard work and experience.  The Dalbar numbers above certainly indicate that many investors are not getting the results they hoped for!

Some Interesting Statistics On Emotion

As I noted above, the US equity markets continue to exhibit unusually high volatility.  200-point daily swings up or down are becoming commonplace in the Dow.  Many investors are finding this volatility just too nerve-wracking and are heading for the sidelines.  Clearly, no one knows when (or if) the recent market madness will end and we will return to calmer markets.

Mark Hulbert, editor of the Hulbert Financial Digest, which tracks the performance of investment newsletters, published a very interesting analysis at the end of last month.  Mark’s latest analysis echoes one of the investment themes that I have preached repeatedly over the last decade.  My theme has been that, because of our emotions, investors tend to buy high and sell low.

Hulbert takes a little different approach to the topic and interestingly turns the table.  He ponders what the equity markets do after investors get too euphoric or too gloomy.  While the concept is the same, I like Mark’s take on it.  Mark analyzed the relationship between the Consumer Confidence Index and the direction of the major stock market indexes, in an article entitled “Driving by looking into the rearview mirror.”  Rather than summarize, I have reprinted the highlights of Mark’s findings just below:

“…I analyzed monthly readings of the Conference Board’s consumer confidence index since 1977, which is when the research firm started updating this index on a monthly basis. I then compared each of the index’s monthly readings over this 30-year period with how the stock market performed over the subsequent month, quarter, year, and two-year period. I also included in my econometric tests various moving averages of the consumer confidence index.

…The historical record shows there to be a slight tendency for the market to move inversely to consumer confidence, with high returns following periods of low confidence and below-average returns following periods of high confidence. In addition, big monthly drops in the index are more often than not followed by market gains than market losses. [Emphasis added.]

The starkest patterns in the data, however, were between the consumer confidence index and how the stock market had performed in prior months. That’s just another way of saying that consumers react to how the stock market has performed recently. When the stock market is going up, their confidence rises too -- and vice versa.

In other words, focusing on consumer confidence tells you a lot about how the stock market has performed in recent weeks and relatively little about the future. But insofar as consumer confidence tells us anything about the future, it's that big drops and low readings are more positive than negative for the stock market.

The bottom line? Consumer confidence is yet another tool in the contrarian's toolkit…”

This is just another of many studies and examples which demonstrate that investors’ emotions are often their worst enemies.  Many investors bail out of the markets when they are well into a steep decline, often selling at or near the lows.  Then they are hesitant to get back in until it seems clear to them that the trend is higher, but that is often after the market has moved up for an extended period of time.  Selling low and buying high.

This is exactly what we found at my company over a decade ago, and that is precisely why I recommend professional money management for most individual investors.  Some investors have the experience and discipline to avoid the tendencies to buy high and sell low.  But most cannot, at least in my experience.

That is why I recommend that you look at the professional money managers I recommend, most of whom employ “active management” strategies which include time-tested systems for exiting the markets, or hedging positions, during extended down periods. 

Unfortunately, it is not until we experience market turbulence, such as we have seen the last couple of months, that do-it-yourself investors take me seriously.  That probably explains why we have seen a significant increase in requests for information on the professional money managers I recommend.

“Neuroeconomics” To The Rescue?

I was recently introduced to a book by Jason Zweig entitled “Your Money & Your Brain.”  It ushers in the new science of “neuroeconomics,” a new discipline that combines psychology, neuroscience and economics to better understand how we make financial decisions.  While I can’t say that I agree with all of Zweig’s guidance, it’s a fascinating read and I highly recommend the book. 

One of the overall premises of the book is to show “why smart people make stupid financial decisions.”  As you might guess, Zweig identifies emotions as a primary enemy of sound financial decision-making.  One of my favorite quotes from the book occurs early on, and says, “…our investing brains often drive us to do things that make no logical sense – but make perfect emotional sense. That does not make us irrational, it makes us human.”

Zweig provides the following basic lessons that have emerged from the new science of neuroeconomics:

*  A monetary loss or gain is not just a financial or psychological outcome, but a biological change that has profound physical effects on the brain and body;

*  The neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine;

*  After two repetitions of a stimulus – like, say, a stock price that goes up one penny twice in a row – the human brain automatically, unconsciously, and uncontrollably expects a third repetition;

*  Once people conclude that an investment’s returns are “predictable,” their brains respond with alarm if that apparent pattern is broken;

*  Financial losses are processed in the same areas of the brain that respond to mortal danger;

*  Anticipating a gain, and actually receiving it, are expressed in entirely different ways in the brain, helping to explain why “money does not buy happiness; and

*  Expecting both good and bad events is often more intense than experiencing them.

The bottom line?  Zweig concludes that most of us repeat poor decision making in regard to investments because we do not recognize and understand our own detrimental behavior.  The obvious solution is to change that behavior, but that’s not always feasible or even possible, but fortunately there is an easier way, as I will discuss later on.

Is Your Risk Tolerance What You Think It Is?

Most qualified investment advisory firms, including Halbert Wealth Management, offer each prospective client the opportunity to complete a  detailed questionnaire asking the investor to provide information on their financial goals and investment expectations, but also to provide information on the amount of risk they think they can take.  Since most investors know rationally that higher returns generally require higher risk, they often check the box next to a risk level roughly equal to their expected returns.

In other words, many investors will indicate that their tolerance for risk is considerably higher than what it really is.  Along the same line, many investors do not pay enough attention to the historical track record, and specifically the prior losing periods.  As a result, they may invest in programs that will be too volatile for their particular risk tolerance. 

At conferences where Investment Advisors gather, a frequent topic of discussion is how many investors indicate that they have a high risk tolerance, but start heading for the exits when their investment programs experience a much smaller loss than what they had indicated they could withstand.   I have had similar experiences with some of my clients.  What happened?  It’s really quite simple – their rational mind completed the questionnaire based on learned behavior when losses were merely “theoretical,” but their emotions pulled the plug on investments when even moderate losses become real.  In other words, emotions often trump rational thought, and scientific studies now seem to prove this.

We all want higher returns.  The key, however, is determining if your risk tolerance matches the level of returns you are targeting.  My experience is that many investors shoot for high returns, but cannot emotionally handle the higher risks that usually go along with such investments.  This is certainly true with many do-it-yourself investors who, as the Dalbar studies prove year after year, often buy high and sell low.

Putting Professionals On Your Team  

As noted above, it was the Dalbar study in 1995 which led me to form my own Investment Advisor firm with the goal of finding successful money managers to recommend to my clients all across the country.  One of the things we learned early-on was that there were tens of thousands of Registered Investment Advisors (RIAs) out there, but only a small percentage were really what I consider successful.  So, we have to look at large numbers of money managers to find those few that are good enough to recommend to our clients.

In addition, we also learned early-on that it is a mistake to simply rely on the RIA to correctly present its past performance record.  We have run into Advisors that simply lied about their track record.  We’ve also seen those that cherry-picked only their best account(s) for us to see.  So in our case, we demand that we be allowed to randomly select the accounts we want to look at to see the real performance record.

Another thing we consider critical when selecting an Advisor is an onsite due diligence visit in their offices.  We want to meet the principals and their staff in person.  We not only want to verify the past performance record as noted above, but we want to know how they make investment decisions and how their system works. 

We also want to see if the Advisor is properly registered (with the SEC in most cases) and if they have had any serious regulatory problems.  There have been times when we’ve simply walked out of Advisors’ offices due to red flags we only discovered on the due diligence trip.

Obviously, doing an onsite due diligence trip is not feasible for most individual investors.  We spend a lot of money each year sending our team all over the country checking out Advisor candidates.  This is one big reason why we have so many clients.  They can be confident that we have done the due diligence, including the onsite visit.  Not all firms like mine go to this trouble and expense.

Are They Good Enough To Manage My Money?

At the end of the day, the ultimate question is whether the Advisor is good enough to manage my own money.  This may come as a surprise, especially to our newer readers, but I don’t manage any of my own money, and I have a sizable portfolio.  I haven’t made a single trade on my own in years.  Nearly all of my money (other than cash) is managed by the professional Advisors I recommend.  

Unlike some investment firms, I have my own money invested with every money manager I recommend.  I experience the same returns as my clients. So, if I don’t believe an Advisor is good enough to manage my money, we simple don’t recommend them.  Not all investment firms have their own money on the table, but I believe this is very important.  Likewise, I want to know that the Advisor has its own money in the program as well.


After reviewing the Dalbar study update and reading Jason Zweig’s book, I am now more convinced than ever that most investors would be better off by using professional money managers (and I don’t mean your broker) to direct most of their investments, especially stocks and bonds and mutual funds. 

One of the reasons I believe this so strongly is that no matter what you may think or say about risk when you make an investment, you really don’t know what your emotional reaction will be when hypothetical losses become real losses.  The Dalbar studies highlight what happens when actual losses occur, and when greed for the highest return takes over.  Investment Advisors see evidence of this almost every day. 

It’s probably a pretty good bet that many of you saw yourselves in the emotional investing traps discussed above.  If so, don’t be embarrassed, as you have plenty of company.  Even many financial services professionals find themselves ignoring the advice they give to their clients and making emotional investment decisions.  I have even done so myself in the past.

Since it’s not an easy thing to completely separate your emotions from your investment decisions, I recommend my clients turn over their investment decisions to qualified professionals that we have thoroughly checked out through our due diligence efforts.

When you choose to invest with one or more of the Advisors I recommend, you open your own individual account with a well-known custodian the Advisors uses (Fidelity, TDAmeritrade, etc.).  The Advisor is given authority to make trades in the account, and to withdraw its periodic management fee.  You receive monthly or quarterly account statements.  In most cases, you can monitor your account online. 

You can close the account whenever you wish, but you probably won’t.  In fact, if you’re like most of my clients, you will be adding money and opening accounts with other Advisors we recommend.  Of course, we can’t guarantee favorable future results, so that’s why we monitor each Advisor closely to see if they continue to meet our (and your) expectations. 

I’m sure you’re wondering how I get paid in this arrangement.  Good question.  Halbert Wealth Management receives a portion of the management fee that the Advisor charges.  Some Advisors split their fee equally with us for referring the clients; others pay us less than half.  Most importantly, the client pays the same management fee as if they had found the Advisor(s) on their own.

You can find the names of the Advisors I recommend simply by visiting our website, and you could certainly access them directly, but the management fee you pay will be the same.  Plus, as I noted above, using Halbert Wealth Management provides the comfort of knowing that we monitor the performance and trading activity of all of the Advisors we recommend on a daily basis.  There have been times when we have pulled our recommendation of an Advisor and advised our clients to close their accounts. 

Just as important, as a client, you will be advised of any new Advisors we find and recommend.  For example, we recently completed our due diligence on an Advisor that specializes in Treasury bonds.  I will be giving you more information on this exciting program, hopefully next week.

We have Advisors that will accept accounts as small as $25,000 and most are at $100,000 or less.  I suggest that most investors open accounts with more than one of our recommended Advisors, just as an added level of diversification.  You can read about each recommended Advisor on the website and quickly get a feel for their area of expertise.

Finally, it does not matter where you live, or that we have not met in person.  We have clients in all 50 states, most of whom I have never met.  But they do have the comfort of knowing that I am in the boat with them, since I invest personally with every manager I recommend.

If the recent extreme market volatility is causing you to lose sleep at night, I suggest now is the time to call us at 800-348-3601 or send us an e-mail at and get the ball rolling.  None of my Investment Consultants are paid on commission; they are highly experienced investment professionals; and they’re just nice guys.  There’s never any pressure.  So, call today and get the professionals on your team.

Wishing you profits,

Gary D. Halbert


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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