In the wake of the market meltdown we see that some very smart people lost money, a lot of it. The news is that several Ivy League endowments and the big California Public Employees Pension fund are down substantially. How could such smart people do so badly? Greed? And, by the way, Madoff got 150 years. At least it was not a life sentence.
I used the old joke about a long prison term in an old man being better than a life sentence to bring our attention back to the Madoff affair. One still wonders about how so many smart people got snookered by this con man. The old saying is still true that if it seems too good to be true it is probably too good to be true. Apparently this same problem infected Ivy League endowment funds, pension funds like California’s with persistently bad investment choices.
High rates of return on investments are seductive and often lead to bad investment choices. At some point along the way, I suspect that the managers of the endowment funds and pension funds that have lost so much money thought about good and bad investment choices along the way. The managers of these endowment funds and pension funds probably knew that some of their stocks and other investments were bad investment choices. But, managers of endowment funds and pension funds are subject to the desires of their constituents, their colleges, and their pension fund members. Everyone knows that something may be a bad investment choice but the money is too good.
So, what is the difference between staying with a winning stock and making a bad investment choice? Fundamentals? Market Sentiment? Market psychology?
There are times when the fundamentals of a stock are getting worse but market sentiment and psychology are such that the stock keeps going up. If you are smart enough to stay with the stock until the day before it crashes and sell just in time, good for you. Most of us do not have a crystal ball and that is why sticking with a stock long past when its fundamentals have gone bad is a bad investment choice.
Following market sentiment and psychology as the pension funds and endowment funds seem to have done make great money for a time. However, the same argument applies. It is a matter of knowing when to get out. If you have the time and expertise for short term and day trading maybe this is your game. For the long term investor who has a full time job managing his or her work and personal life, too much market timing can be a bad investment choice.
The managers of the above mentioned endowment funds and pension fund work full time at managing their assets and they still got seduced by high returns and made bad investment choices. If that is the case how can a person with a life and a half outside of the market expect to avoid bad investment choices if stretched too thin.
The point gets back to weekly review of your long term investment plan, keeping your portfolio down to a manageable number of investments, and staying true to your long term principles. The old saying that you have not made a profit until you have taken a profit applies here too. If you are in a hot stock and the fundamentals start to look a little shaky even as the stock continues to rise, take a profit. As the stock continues to rise you may feel left out but when it crashes you will not be guilty of a bad investment choice.