Streetwise for Sunday, September 5, 2021

These are dangerous times. As the equity markets propel themselves upward, suddenly investors tend to believe they have enhanced investment skills.

Yes, you may have some investment successes, which is fine, and I applaud you. Just do not let your successes lead to delusional over-confidence, meaning you conclude unjustifiably as to your ability to successfully time the markets.

If you fantasize about being able to avoid the downturns but still participate in the recoveries, ask yourself these simple questions:

1) What repeatable methodology would you use to decide to sell at or near the highs of the market?

2) What process would you follow to buy back in after a major downturn?

3) And would you have had the discipline repurchase shares near their lows?

Now let us be honest. If you could successfully answer those questions, you would likely be on your yacht in the Caribbean with a cell phone and a line to a discount brokerage house.

To cast this in a slightly different light, reconsider those three items with the idea of where you would be if you had simply ignored all the volatility of the period from late February of 2020 through the end of August 2021.

The answer is you would likely have had a more profitable experience, while avoiding all the possibilities for error from a wrong move. Not to mention averting the ensuing aggravation.

It turns out that most investors are much better off ignoring the market’s volatility than trying to time the market. Yet why is that some believe that they have this, “investment thing,” worked out?

The problem is referred to in psychology as the Dunning-Kruger effect. In simple terms, it is a cognitive bias in which people with low ability at a task overestimate their ability.

It is related to the cognitive bias of illusory superiority and comes from the inability of people to recognize their lack of ability. Without the self-awareness of metacognition, meaning the capability of reflecting on your thinking and working with more abstract ideas, you cannot objectively evaluate your competence or incompetence.

As described by psychologists David Dunning and Justin Kruger, the bias results from an internal illusion of low ability and from an external misperception of high ability; that is, "the miscalibration of the incompetent stems from an error about the self, whereas the miscalibration of the highly competent stems from an error about others.

What does all that mean? Simply put, in terms of investing, you think you can and therefore you can, but you cannot.

What motivates people to take investment positions? Most often it is pure emotion. People often call me when they are happy with the way things are currently and say, “I am doing great...but I want you to liquidate my portfolio?”

This happens more often than you might think. Yes, investors can be persuaded not to pursue such a course of action but that is not the issue. The question is why they came to such a conclusion in the first place.

Unfortunately, as the Street’s prognosticators dwell on an exogenous event that might not bode well for the markets, that drumbeat of bad news feeds upon itself and intensifies in a self-perpetuating cycle.

From there it is a small step to panic. Too often, the exit is “capitulation," meaning total surrender or doing whatever it takes to make the pain go away.

There is no shortage of studies demonstrating that following a supposed expert could work to someone’s advantage. While those experts may be right in their way of thinking, that does not mean it is right for you.

If you watch television, there are continual advertisements for medications designed to cure a host of medical challenges you did not know you had and probably do not. Yet, their rhetoric as to a drug’s effectiveness, may be correct but not for you.

As social primates, to do the exact opposite of your peers requires fighting your basic instincts. You must have conviction in your ability to do what others cannot or will not. You must have the discipline to act on your beliefs, despite life’s mayhem.

Lauren Rudd is a Managing Director with Raymond James & Associates, Inc., member NYSE/SIPC. Contact him at 941-706-3449 or Lauren.Rudd@RaymondJames.com. All opinions are solely those of the author. This material is provided for informational purposes only, is not a recommendation and should not be relied on for investment decisions. Investing involves risk and you may incur a loss regardless of strategy selected. Past performance is no guarantee of future results.