Remove the Stumbling Blocks to Trading

 | Sep 24, 2012 | 4:00 PM EDT
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As I prepared to watch the Ravens game last night, I spent some time on the phone with my curmudgeonly friend from Chicago, talking markets and investing. Like me, he spends a lot of time talking to people about investing and gets asked a lot of questions by individuals who have an interest in the markets. Also, like me, he finds a high sense of frustration with people who lose more money than they should because they simply refuse to follow the basic concepts of investing.

The big question that Fred and I were both trying to answer last night is, "Why is this so hard?"

Individual investors have been proven to be a great contrary indicator. When they are excessively bullish, it is time to sell. When they are puking out stocks and huddled under the desk with a bottle of cheap tequila, it is time to be a buyer of common stocks. They chase performance, abandoning funds or strategies in favor of those that have worked recently. Retail investors tend to buy what is hot and popular right now, and that ends up costing them money.

Part of the underlying reason is psychology. When we hear our friends and associates talking about all the money they made in Apple (AAPL) or Google (GOOG) last year, or how they bought a new BMW with day-trading profits, it is hard to resist jumping on the bandwagon. It seems exciting, and we fear looking foolish by missing out on the action. Of course, by the time everyone is super excited about it, the opportunity is usually long gone.

John Templeton once said that you cannot have superior returns by doing what everyone else is doing. You have to eschew the exciting and popular and look for the opportunities that no one else likes. My portfolio is not going to be great cocktail-party chatter. Hess (HES) and Kelly Services (KELYA) are not especially exciting companies, but the shares were safe and cheap. These companies are not going to change the world or introduce exciting new products that our kids clamor for, but they are profitable companies that no one cares about. They will be boring right up until I sell them in a strong economy a few years from now for several times what I paid.

The other problem that individual investors have is Wall Street. Wall Street exists to sell product. Goldman Sachs (GS) is different from Ford (F) only in the product it sells. Goldman needs to create and sell products in order to profit. There is not enough profit margin in plain old stocks and bonds, so it has to create products that have financial bells and whistles to sell to retail investors.

When I was a very young broker, I questioned the wisdom of some new flavor-of-the-day product that was being issued and promoted. The market sector was already at new highs, and it seemed silly to be offering this as a hot investment to clients. "Son," my manger told me, "you have to sell the dog food the hounds will eat." It is much easier to sell a good story than a good investment.

The asset management industry has not been much help to us either. We all know that most fund managers underperform the indices. The sad simple truth is that the herd instinct will make sure this always is the case. The simple truth is that if you are a 35-year-old fund manager making $300,000 plus bonus, your major goal when you go to the office each day is not to maximize profits for investors. You major goal is to not get fired from this great job. If everyone else on the Street is buying Apple (AAPL) and IBM (IBM), then that's the safe move. If they fall, then it is just a bad market. If you load up on unknowns like Orchids Paper Products (TIS) and Sun Bancorp of New Jersey (SNBC) and they fall, that's your fault, and you get fired.

Why is it so hard? Our own personalities work against us, and the professionals in the field seek to profit from that. Wall Street does not exist to assist us in making money. To stand against the crowd and ignore the alleged professionals can be difficult in any endeavor, but it is even harder when your own money and dreams are on the line. Tomorrow I will look at how to tip those odds back in your favor and make it less difficult.

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