“When everyone thinks alike, everyone is likely to be wrong.”
— Humphrey Neil
Simply put, the best investors are contrary thinkers. It pays to be contrary. Investing with the trend only gets you caught up in financial manias and bubbles. Human nature is what causes us to replicate the thoughts and actions of others. Despite the achievements in technology, human psychology has remained constant. Because of this, we still have the boom and bust cycle which is no different today than what it has been throughout history.
It makes little sense to copy what everyone else is doing when it comes to investing. If everybody is chasing a single asset class, that asset class has to be overvalued. When everyone was buying dot com stocks, other assets, including precious medals and other commodities, were ignored. This demonstrates that the best time to buy something is when nobody is talking about it.
Over time, these cycles repeat. A bull market begins when savvy investors begin buying an asset that is unloved and has been forgotten about. The first stage of a bull market flies under the radar and gets little to no media attention. As that asset class gets more traction and eventually shows a track record of rising prices, it attracts more investors and more media attention.
Eventually, a third stage unfolds. The real mania begins once that asset price has passed it’s fair value yet investors keep pouring money into it. You see magazine covers showing it off and it’s on CNBC all day. When that happens, it is a bubble and you should lay off of it. The day of reckoning will eventually come and the price of that asset will usually drop by 70% or more.
If you’re like most people, reflect back at your own history with mutual funds. As the saying goes, mutual funds do really well until you put your own money into them. This is true among the best performing mutual funds. This is because a mutual fund’s assets are in that third stage when you buy it. Otherwise, it would not have had the track record of being a top performer.
A mutual fund that has a great ten-year track record most likely holds assets that were undervalued when the fund manager first bought them. Over time, they kept rising in price until they were overvalued. At that point, those funds are featured in every magazine, on every financial website, and other media sources. If you choose to buy that fund, you either think it can continue going up while holding the same assets. Or, you think the fund manager is savvy enough to sell one set of assets and invest in another while getting the timing right. History suggest this is highly unlikely.
One of the most frustrating things is knowing when a bubble has peaked. When you get to a point at which prices seemingly couldn’t go any higher, they double. This is usually how it goes. Meanwhile, you hear from family and friends who claim they are making tons of money. And you realize you’re wasting your breath by explaining that a bubble is about to burst. At the same time, you don’t have 100% trust in your own judgment and are tempted to jump in yourself. Prices never get so high to the point at which they can’t go higher. On the same token, no boom ever eludes a bust.
For instance, consider gold prices. Many of the talking heads in the media are declaring the end of the bull market for gold. How can they be so certain? In previous bull markets, gold prices dropped 30-50% at certain points. After that, the bull market resumed and then doubled or tripled in value. In real estate, many people were calling for a bubble as early as 2002. In many localities, prices more than doubled from there.
If only it were that easy to buy low and sell high. It’s such a simple concept yet so few can pull it off.