Published: Dec 15, 2016 2:55 a.m. ET
Denial can cost you in more ways than one
With U.S. stocks in record territory, investors need to take their emotional temperature. Emotions can be your worst enemy when it comes to money and stocks, especially during big, rapid market moves that can warp your thinking in unforgiving ways — like these:
1. Forgetting that purchase price matters
Since the presidential election, the Dow Jones Industrial Average DJIA, -0.04% the S&P 500 SPX, -0.18% the Nasdaq COMP, -0.36% and other major U.S. stock indexes have posted big gains. Understandably, you may be wanting to throw money at stocks right now.
Not so fast. You are guaranteed a worse return with money invested today than you’ll get with money invested before the election, when U.S. stocks were considerably cheaper. Stocks are ownership units of businesses that are worth the profits they deliver in the future. Pay more for future profits, and your return necessarily declines. Wait for your pitch.
2. Giving in to greed
Maybe your allocation is too low on stocks, and you should add. But why does it take a surge in stocks to make you think you don’t have enough in stocks? The time to consider your allocation was before a big market move. Chances are your allocation isn’t too light on stocks. You just think it is because you’re being greedy. This line of thinking will lead you to add to stocks after they’ve gone up, and sell after they’ve dropped, trapping you in a vicious cycle.
3. Playing momentum
What goes up, stays up. Until it doesn’t. And the smart-money investors can never tell you when the momentum will stop. Except there is ample evidence for investors to realize when stocks have peaked. It’s when investors have thrown their last dollars at the market, because the data show investors buy high and sell low, following momentum in both directions just before it’s about to turn. The momentum factor may exist, but individual investors have proved remarkably adept at letting it punish them with losses rather than being able to exploit it.
4. Giving in to social pressure
Closely linked to momentum is social pressure. You see other people enjoying gains, and you want to enjoy them too. Also, you see other people buying stocks, so it feels safe for you to do the same thing, at any price. And even if you have a big slug of assets in stocks, you always want more. You want to enjoy the good times with everyone else to the maximum extent possible.
Be wary. A little misanthropy can serve you well in investing. If other investors are buying stocks at nosebleed prices, sell them your shares.
5. Forgetting that earnings matter
Some investors believe corporate profits will be higher than previously thought because of Donald Trump’s election. Accordingly, higher stock prices are justified. But no one knows if earnings will be higher, or by how much. Is it justifiable, for example, that shares of United States Steel Corp. X, -3.18% are up more than 60% since the November election? Will U.S. Steel produce so much more profits because of increased government infrastructure spending? Maybe. But anyone who tells you they’re certain is kidding themselves — and you.