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Learning From Investing Mistakes

As we’re faced with another period of dramatic market swings, investors who panicked and sold everything during the last crash have a chance to take a different course this time. Will they?

Some investors who got out of the market last time learned from that mistake. Others, unfortunately, did not. Based on what I’m hearing from clients, financial planning newsletters, and other financial planners, investors can be divided into three groups.

The largest group (for my clients, that was about 77%) “stayed the course” through the last crash. Around a third of those needed some help in processing their feelings to avoid taking action on their fear and selling out. This time, most of them seem to be comfortable handling their own anxieties and staying in the market.

The second group are those who did sell some equities at the bottom. Their attitude could be summed up as: “This is nothing, the last crash prepared me for this. I learned my lesson and I am staying put!”

The third group, fortunately the smallest, also sold some equities at the bottom. A few of them sold everything and have suffered the greatest losses because they missed most of the market recovery. The recent market volatility is triggering these investors’ fear even more strongly than the last crash did. They are the ones making panic-stricken calls to their financial planners.

Many of them are wanting to make a 100% jump out of equities, with a high probability of hurting themselves again, just as they did last time. Instead of learning from their earlier mistakes, they are experiencing what could almost be described as PTSD. They were unable to process and resolve the fear that caused them to sell last time. Now, as Lady Gaga sings, they’re “on the edge,” not of glory but of making the same mistake again.

If you think you might fit into this third group, here are a few suggestions to help you avoid acting on your fear:

1. Stop looking and listening. Avoid media reports and talk shows discussing the market. Don’t read daily stock reports. Don’t focus on whether the Dow was up, down, or sideways.

2. Take a cold, hard look at the numbers from last time. To illustrate, let’s assume four investors each had a $100,000 portfolio at the market top in October 2007. Investor A sold everything and went to cash at $100,000, before the markets started to fall. Investor B, like the majority of investors who got out of the market, sold in September 2008 and ended up with around $86,000 in cash. Investor C finally couldn’t stand the stress anymore and sold in March 2009, right at the market low, when the portfolio had dropped to $60,000. Investor D, who had a well-diversified portfolio, stayed in the market.

The all-cash holdings would have earned interest of around one percent at best. At the end of August 2011, Investor A had $100,000, plus perhaps $2000 in accumulated interest. Investor B had perhaps $87,000. Poor Investor C had around $60,500. Investor D’s portfolio, however, was worth $103,000. Staying in the market does work.

3. Have a buffer between your fears and the action of selling. Even a “rule” that you sleep on a decision before you sell might help. Ideally, this would be a financial therapist or a fee-only financial planner who can listen to your fears and can be trusted to give advice that’s in your best interest.

Finally, remember that action might feel like a cure for anxiety, but the wrong action will only make things worse.

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