THE ADDICTION

Those who’ve had any brush with addiction know an addict will go to any length to support the habit, including stealing, lies and deception. The addict is aided and abetted by co-dependent friends and family members who cover up for the addict’s bizarre behavior and pretend nothing’s wrong. Breaking the addiction starts with the co-dependents recognizing their role and refusing to provide support to the addict.

Investors have been turned into stock market addicts with their addiction aided and abetted by the media, the financial community, analysts, neighbors, friends and the local checkout clerk. Since 1990, when the Internet began to mainstream investing to the average investor, millions have been lured by the promise of the lifestyles of the rich and famous by simply playing “the game.”

Now, after eight years of a bull market, investors are piling into the market for their next fix, living from one headline to the next looking for reassurance “this time is different.”

But why wouldn’t they considering they have been repeatedly told the stock market is a “sure thing”, a near guaranteed way to make money. It’s so easy, after all. You just “buy and hold” stocks and the market will return 10% a year just as it has over the last 100 years.

This fallacy has been repeatedly espoused by pundits, brokers, financial advisors, and the media. Even Dave Ramsey, the famous debt counselor, espouses buying and holding four mutual funds (25% in each of growth, growth & income, aggressive growth and international) and then bingo – you will make 12% per year.

If it were true, then explain why roughly 80% of Americans, according to numerous surveys, have less than one years salary saved up on average? Furthermore, no one who simply bought and held the S&P 500 has ever lost money over a 20-year time span. Right?

Not exactly.

Here is the problem.

No matter how resolute people think they are about buying and holding, they usually fall into the same old emotional pattern of buying high and selling low.

Investors are human beings. As such we gravitate towards what feels good and we seek to avoid pain. When things are euphoric in the market, typically at the top of a long bull market, we buy when we should be selling. When things are painful, at the end of bear market, we sell when we should be buying.

In fact, it’s usually the final capitulation of the last remaining “holders” that sets up the end of the bear market and the start of a new bull market. As Sy Harding says in his excellent book “Riding The Bear,” while people may promise themselves at the top of bull markets they’ll behave differently:

“No such creature as a ‘buy and hold’ investor ever emerged from the other side of the subsequent bear market.”

Statistics compiled by Ned Davis Research back up Harding’s assertion. Every time the market declines more than 10% (and “real” bear markets don’t even officially begin until the decline is 20%), mutual funds experience net outflows of investor money.

Fear is a stronger emotion than greed.