The way we buy cars offers a great example of what I call “binge/purge” money management.
For the auto industry, 2015 was a banner year. Nearly 17.5 million vehicles were sold, with SUVs and trucks leading the way. Analysts, such as Eric Lyman of TrueCar, attribute the strong sales, in part, to low gas prices. “Because your operational costs are a bit lower … people might go for that SUV or a bigger engine or a bigger vehicle that’s less efficient.”
It happens all the time. When gas is cheap, trucks and SUVs are the best-sellers. When the price of gas goes up, so do sales of small, fuel-efficient cars.
Outside circumstances change, and our behavior follows.
A common mistake with investing
Binge/purge is standard operating procedure for many investors as well. It can be seen in annual surveys in which investors underperform the funds they invest in. For example, a Morningstar study found that in a 10-year period through the end of 2013, the average mutual fund investor underperformed the average fund by 2.5% per year.
How can that happen? When the market falls, fear prompts a run for the exits. “In 2009,” Morningstar noted, “money flew out of stock funds, but that proved to be the bottom of the market and a great spot to get in.” Once they’ve gotten out, binge/purge investors often find it much more difficult to get back in, and usually do so only after the market has far exceeded its previous high.
A better way
One of my favorite investment writers is Jason Zweig, who writes the Intelligent Investor column in the Wall Street Journal. After hundreds of columns in which he closely studied the market, one principle stood out.
“From financial history and from my own experience,” Zweig wrote, “I long ago concluded that regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.”
In other words, bull markets are followed by bear markets, which are followed by bull markets, and on and on. Investing is best done from the perspective of a long-term investor, not a short-term trader. Recognize that something you can control, time in the market, is far more important to your success than the impossible-to-achieve goal of perfect market timing. Find an investment strategy you can stay with in good times and in bad, and then, in fact, stay with it.
The same principle can be seen with many financial decisions, such as buying a car. Just like the stock market, gas prices are cyclical. Low prices are followed by high prices, which are followed by low prices, and on and on. Vehicles are best bought with cash and kept for a long time—long enough to drive them through several cycles of changing oil prices. Buy vehicles you can afford to drive no matter how much gas costs. How will that SUV you’re thinking of buying impact your household budget if when gas goes to $4 per gallon?
No more financial binging and purging
Recognizing the cyclical nature of the economy is one thing. Resisting the temptation to be swayed by especially good or bad times is more difficult. As Zweig cautioned, “…humans perceive reality in short bursts and streaks, making a long-term perspective almost impossible to sustain…”
Developing that long-term perspective is an important part of what it means to be proactive with money instead of reactive, an initiator instead of a responder, a steward or manager—or, as I prefer, a wise builder—instead of a consumer.
Winning with money is about making financial decisions that work well under today’s circumstances, and would still hold up under very different circumstances.
Are you considering a significant financial decision right now? How will you feel about it when circumstances change, for better or for worse? How much would today’s circumstances have to change in order for you to regret the decision you’re contemplating?
What’s an example of a financial decision you’ve made that has held up well under different economic conditions, or one that didn’t hold up so well?