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How Evidence-Based Investing Saves Long-Term Wealth: Avoiding the “Big Mistake”

"Buy low, sell high." Sure, it’s a tired cliché, but it’s actually good advice.  Everyone knows it.  Most of us may even manage to do it by simply leaving well enough alone instead of constantly questioning our investments.  This is especially so if you’ve preceded your inactivity by setting up a solid plan and investing accordingly.

But here’s the challenge: Even the most stay-put investor is still at risk for making that rare “big mistake.”  It happens when seemingly game-changing news tricks you into falling for a different financial platitude: This time is different.

The Financial Crisis of 2008/2009

Even if you only deviate from your routine in the face of an extreme event, the financial damage done can last a lifetime.  One of the biggest, most recent anomalies was the Financial Crisis of 2008/2009.  At the time, many investors (and many advisors as well) wondered whether the markets would ever recover.

Although we are almost 10 years removed from this time, it was a highly emotional period for investors.  In fact, one of my favourite financial commentators Nick Murray refers to this period as The Great Panic. To put this into context, let me share a few real-life investor anecdotes.

Take “Joe,” for example, who reached out to me to inquire about my services in October 2008.  At the time, Joe had a $2.6 million portfolio.  He had a very stable and successful business and wasn’t planning to tap into his investments for a couple of decades.  His portfolio wasn’t perfect.  Some of his holdings had high expense ratios, and some of them could have been better managed.  But overall, they seemed relatively well diversified and well structured.  He was doing okay.

Still, Joe was thinking about abandoning his balanced approach and moving to cash.  I offered Joe this timeless advice:  

When we’re in the thick of a bear market, nobody knows when or how it might reverse course. But we do know it is highly likely it eventually will – often quickly and without warning.  

If you try to time when to be in and out of the market for optimal effect, you must not only correctly guess when to get out, you’ve also got to predict exactly when to get back in.

So, November 2008 came and, along with it, a second major market drop. This was too much for Joe.  In late November, he called me and told me something like this:  “Thanks for your time.  However, this time really is different, and your history and evidence doesn’t matter.  I have sold my entire portfolio and moved all my investments into cash.”

I don’t know what happened to Joe after that, because we went our separate ways.  In the short run, he was right.  We didn’t know it then, but the third (and final) major drop in the equity markets arrived in January/February 2009.  Using historical index data and assuming a balanced portfolio of 60% Global Equities and 40% Global Bonds, liquidating his portfolio ahead of this final dropped “saved” him from a loss in the range of $200,000.

Once again, using index data, had he simply held his portfolio he would have made back the “$200,000 loss” by May/June 2009 and then been almost 20% higher by November 2009.  In dollar terms, that is over $500,000 higher than he was in November 2008.

I doubt Joe had the nerve to reinvest anytime in 2009 …  it’s far more likely he waited until the recovery was in full swing, buying higher than necessary and sacrificing returns that could have been his by simply holding tight.  Or, for all I know, he’s still sitting in cash today.  If so, he has so far given up about $3 million in potential wealth … even after assuming reasonable fees for investment management, financial planning, and (most importantly in Joe’s case) behaviourial coaching.

If every investor’s story turned out like Joe’s, I doubt any financial advisor would still be in the business.  It would be too depressing.  Fortunately, there are many success stories too. Around the time Joe was making his “big mistake,” another investor came to me in mid-February 2009, also thinking about cashing out.  This investor was a client of mine; using exactly the same evidence-based philosophy and advice I gave Joe in November 2008, I was able to convince them to hold tight.  Many years later, we jokingly referred to this piece of advice as “talking them away from the edge of a cliff.”

To put this one piece of advice in dollar terms, this client wanted to sell $1 million worth of equities.  If we again assume a typical globally diversified, low-cost index-based equity portfolio (similar to the one described above), that $1 million would be worth over $3 million as of June 2018.  So averting this one big mistake has paid for itself many times over during the 9½ years .

In short, the best way to avoid the “big mistake” is to have faith in the evidence and use history as your guide. Anytime you find yourself wondering whether, this time, it’s different, remember:  Odds are much higher that the principles of sensible investing are still the same.

Learn more about my investment philosophy