Understanding Your Investment Timeline

One of the biggest motivators for speculative investing remains hidden to most people. If you ask someone who buys and sells stocks with the goal of realizing short-term gains why they do it, they will probably say that it's to make money.

Of course, making money is the goal of every investor. However, repeated analysis has shown that the most consistent and reliable returns are most likely to come from holding a diverse portfolio over the long term. This is what you do if you're really serious about making money over an investing lifetime. But buying an investment and seeing it go up gives the immediate thrill of winning. More than the good feeling of monetary gain, it gives the deep psychological satisfaction of being in control.¹ 

When it works, if feels something like this: You were smart enough to identify a bargain. You had the guts to put money on it. And now you enjoy the feeling of being a winner. Psychologists have long known that this is what makes gambling so addictive. And conversely, this is why gamblers who are not winning will keep playing until they can make the feeling of being a loser go away.

Since the prices in the market (theoretically) reflect all available and even speculated about information on an investment, it would be logical to think that significantly undervalued securities are rare. After all, by the time you've heard about the latest hot stock or fund, so has everybody else. But analysts have been noting that when an investment gets a reputation for being the next big thing, the influx of money from short-term investors can temporarily raise its current price in a sort of self-fulfilling prophecy.

Wall Street Journal columnist Jason Zweig explains how this can happen to an exchange traded fund (ETF). "(Investors) buy the fund in droves, pouring in hundreds of millions or even billions of dollars. The ETF's managers take that cash and pump it into the stocks the fund already owns. If those stocks are small and thinly traded, the funds own buying will drive their prices up."² This will raise the ETF's value further, attracting even more money, and repeating the cycle.

Zweig gives the example of ARK Innovation (Ticker: ARKK). This actively managed "disruptive innovation" fund had nearly a quarter of its $1.6 billion in assets in only nine stocks. As returns flared, new money piled in, the underlying stocks soared, and over the next two years the fund's assets ballooned to $25.5 billion. Then performance faltered, the hot money fled, and ARK Innovation has lost an average of 27.9% annually over the past three years.

On its way up, the fund made a lot of people feel very smart -- temporarily. But when the underlying stocks reverted to more normal prices, many investors received an expensive and unpleasant education in the risks of speculation.

Understand that emotions, both good and bad, almost always drive poor investing decisions. By contrast, the road to a successfully funded retirement is marked by diversification, discipline, and a realistic view to market rates of return over the long-term.

 

1. http://go.pardot.com/e/91522/pmc-articles-PMC2658737-/95cjr3/2406465590/h/v-h5mIGD54Jv75H81Ql-hND05DjnrpKmvAM4VG50Kao
2. http://go.pardot.com/e/91522/self-inflated-returns-258e875e/95cjr6/2406465590/h/v-h5mIGD54Jv75H81Ql-hND05DjnrpKmvAM4VG50Kao