How Not to Buy at the Highs or 294 Chances to Screw Up

via Systematic Relative Strength

Being an investor is tough.  Nothing moves in a straight line, except maybe a fake Bernie Madoff-type account.  Everything proceeds in sawtooth fashion, and each up and down seems cleverly calculated to play on your emotions just enough to tempt you to take action at the wrong time.  In fact, we could be headed into a correction right now.  Carl Richards of Behavior Gap has an awesome illustration of the basic problem:

Source: Carl Richards/Behavior Gap  (click to enlarge)

According to DALBAR data, the dips are pretty good at causing investors to bail out.  DALBAR’s most recent study released in March 2012 showed that the average stock fund investor made annual returns of only 3.49% over the last 20 years versus an annual return of 7.81% for the S&P 500.  The average investor “generally abandons investments at inopportune times,” according to their research.  That’s a polite way of saying that investors panic when the market goes down and they sell out, often near the lows.

And there is plenty of temptation.  According to uber-reliable Ned Davis Research, as summarized in this Wells Fargo market update, there have been 294 dips of 5% or more since 1928.  In other words, you usually have three or four chances a year to screw up.  Considering that most investors have a 20-30 year life cycle, that’s a lot of dips to deal with.

Read the rest here.