There’s no doubt about it: Investing can be maddening. Stocks that look like they’re going up can end up going down. And investments that look like they’re headed for the dustbin can suddenly bounce back—like Tim Finnegan—at the most unexpected times. This leaves investors in a difficult position. That’s because the right thing to do often feels like precisely the wrong thing. Thus, investing requires us, quite often, to act contrary to our own intuition. Below are four such examples.
1. Buy low. When consumers walk into a retail store, do they prefer the products that are on sale or do they head straight for the full-price items? For most people, the answer is clear: All things being equal, everyone prefers to pay less rather than more. But when it comes to the stock market, intuition often leads us in the opposite direction. In our minds, price is associated with quality, so we end up being attracted to investments that are more expensive, not less. And further, because it’s natural to expect trends to continue, we assume that if the price of an item has been going up, it will continue going up. On the other hand, if a stock has been falling, we assume that there must be something wrong with it and thus expect it to keep falling.
This logic is, of course, backwards. Like any other prospective purchase, we should be more interested in buying an investment when its price is lower. I’ll acknowledge, however, that this is easier said than done. If an investment has been beaten up—and especially if you’ve incurred a loss on it—it’s understandable to want to distance yourself from it. And even though the price might be attractive, it’s admittedly difficult to buy more of an investment at a time like that. It just doesn’t feel right—and for good reason. In psychology, one definition of insanity is to do the same thing over and over, expecting a different result. Through that lens, it might seem literally insane to put more money into an investment that’s declined in price, expecting it to suddenly behave differently.
As consumers, we’ve been trained to think this way—to see price as an indicator of quality—so it’s a deeply ingrained intuition. There’s a famous story, in fact, about the eyeglass company Warby Parker. The founders—a group of business school students—believed they could run a profitable business selling glasses online for $49. When they consulted their marketing professor, however, he argued that this was a bad idea. Consumers, he said, wouldn’t trust the quality of a product that was too inexpensive. Instead, he suggested they set the price much higher. Warby Parker is now a very successful business selling glasses at $95.
How can you get over the psychological hurdle of buying something that looks unattractive only because of its low price? The simple solution, in my view, is to stick to a discipline of rebalancing your portfolio. Suppose you start with an asset allocation of 50% in stocks and 50% in bonds. If the stock market drops such that your allocation to stocks falls to just 45%, you would buy more stocks—enough to get back to 50%. It still may not be easy to buy stocks when they’re depressed, but I find that a framework like this can make the decision easier.
2. Don’t look back. When I think about the stock market, I often think of Dickens’s line: “It was the best of times, it was the worst of times.” This idea, I think, describes the stock market perfectly. Virtually every year, some categories of stocks deliver strong performance while others lag. The challenge, though, is that these categories trade off from year to year. There’s no such thing as permanent outperformance.
Between June 2001 and June 2007, for example, European stocks gained 120% while the U.S. stock market gained just 46%. Since that time, however, things have reversed. Through the end of March, domestic stocks have gained 296% while European stocks have gained just 45%.
We’ve seen similar reversals in highflying tech stocks. In the depths of the pandemic, stocks like Shopify, Zoom and Peloton were all home runs. But this year, Peloton is down 26%, Zoom 36% and Shopify 50%. They’re not the only ones. As a category, stocks like this have declined after their run of strong performance.
Even in the quieter world of bonds, investment categories frequently trade places. Two years ago, municipal bonds—traditionally a very stable asset class—lost value quickly in response to worries about municipal finances when the economy shut down. High-yield bonds also lost value at that time. Both categories subsequently bounced back, more or less in unison. This year, though, they’ve again lost some value, in response to rising interest rates. Meanwhile, the big winner recently has been something else entirely: inflation-protected bonds, which for years were entirely uninteresting because inflation had been so low. Suddenly, they’re everyone’s favorite bond.
How should investors navigate this constantly shifting landscape of winners and losers? Again, I think it helps to have a framework. Continuing with the above example, if your portfolio has a 50% allocation to bonds, you might designate further targets within that 50% to specific categories of bonds. You might allocate 20% to municipal bonds, 20% to standard Treasury bonds and 10% to inflation-protected Treasury bonds. Then try hard to stick to those allocations. Hold those three categories through good years and bad, recognizing that they will inevitably trade off over time.
When I was a kid, I remember going to a horse race with a friend’s family. My friend won two dollars on one of his bets and immediately said, “I wish I’d bet more.” It’s the same with investing. At any given time, every investor will wish they’d owned more of one category than another. But that’s the price investors must pay for the benefits of diversification. When you own a diversified portfolio, you are, by definition, accepting the reality that each year you’ll own some winners and some losers. But you can’t know in advance which will be which in any given year. Thus, I suggest choosing a sensible mix of investments, then not looking back.
3. Don’t put the cart before the horse. If you’re like most people, you don’t like paying taxes. And you certainly wouldn’t go out of your way to create a tax bill for yourself. That’s understandable. When it comes to your portfolio, though, it’s important to consider both investment and tax considerations as you make decisions.
Many investors, I’ve noticed, prefer to sell only investments that have losses, or perhaps just small gains, to minimize their tax bill. On the surface, this makes sense. But this is another area in which investing is counterintuitive. From an investment perspective, the right thing to do is to sell investments that have done well. That’s because they’re the ones that may now be overvalued. At the very least, they’re the ones that may be overweight relative to your asset allocation targets. But from a tax perspective, these are the investments you’d least like to sell.
How can you manage this inherent conflict? In my experience, it doesn’t need to be an either-or type of decision. If you want to sell some investments, I generally recommend selling a mix. Sell some with big gains, some with small gains and some with losses. That, in my view, is the way to balance both the investment and tax objectives.
4. Don’t worry about IRA distributions. In years when the stock market is down, investors often fret about taking their required minimum IRA distributions. They hate the idea of selling when the market is low. Here’s the reality, though. While IRA distributions do need to come out in cash, there’s no reason that you can’t immediately reinvest the distributed funds. In your taxable account, you can buy back the investments you’d sold in your IRA.
Taking an IRA distribution when the market is down actually results in a more favorable outcome than if you’d taken the distribution when the market was higher. For the same number of dollars—and thus, the same tax bill—you’ll end up with more shares of a given investment outside your IRA. This will provide greater appreciation potential in your taxable account. And that’s an advantage because of the more favorable capital gains tax rates that will apply.