The psychology of why investors "Buy High/Sell Low," and how to avoid that trap

For 2009, the S&P 500 gained 26.5%, the Dow Industrials gained 22.7%, the NASDAQ gained a phenomenal 45.4% and Barclays Aggregate Bond index gained 6.1%.  European exchanges gained 24-32% while Brazil, India and China returned once in a life time gains of 82.7%, 92.6% and 118.7%.  These were the best results for world stocks since 2003, which, not coincidently, was also the first year following the last bear market.  Yet millions of investors failed to participate in these gains.  Why?  Because they panicked at the worst possible moments last January, February and March, went to cash and have stayed in cash.  Those investors will never make up the gap and will be lucky to retire ever!

Not all our clients could "stay the course."  About a half dozen fired us the first week of March and liquidated their portfolios at 13 year lows.  Another half dozen liquidated their portfolios between July and October 2002 at the tail end of the last bear market.  However, a number of our clients moved excess cash into their investment accounts during the crisis.  We took those clients fully invested by April, and they picked up hefty gains in nine months on those investments.

At least in US stocks, there's never been a bear market that wasn't followed by another bull market.  We can imagine scenarios where stocks don't recover after a bear market.  Those scenarios generally involved investors foraging for food among smoking cities following a nuclear war, for example.  In any scenario where McDonald's still sells hamburgers, GE still sells power plants, JP Morgan still dispenses cash from ATM's and Pfizer still sells Viagra, we would be highly confident that the market will recover.  What information can we, as investment advisors, give our clients to enable them to stand strong during the next bear market?

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