How to Get Rich Off Other Investors’ Mistakes
Blunders and Market Inefficiencies That Smart Investors Can Profit From
Are you a mistake-prone investor? Do you chase winners and sell after a market correction? If so, learn how to turn it around and get rich off other investors’ mistakes. Here are three investing tips that can help you make money by going against the grain.
Avoid Chasing Performance and Invest in Value Stocks
Value stocks are those that trade for less than their intrinsic values. Value index funds include stocks with low prices relative to their earnings, sales, and book values.
Momentum and growth stock investors, however, make the mistake of chasing performance and buying stocks as they reach new highs. These investors believe in the trend — a rising stock will continue to go up in price. The momentum investing mistake is that once the stock’s PE ratio gets too high, the stock becomes overvalued and eventually the stock price drops to fair value.
Ultimately, it’s difficult for the momentum investor to know when to pull the plug and sell.
During the short term, there are periods when value outpaces growth and vice versa. Yet, over the long haul, the research is clear that value investors outperform momentum investors.
In the past few decades, large-cap value stocks returned 9.03 percent and large-cap growth (momentum) stocks returned 8.60 percent annually. So, if you invested $10,000 in value stocks in 1990, at the end of 2015, your $10,000 would be worth $94,694 in contrast with $85,435 for value stocks.
By tilting your investment portfolio towards value stocks and funds, you will be able to seize an opportunity to profit from the momentum and growth stock mistakes of others.
Avoid the Hot Funds
A big investor mistake is piling into last year’s top funds. You might be tempted by those “top performing funds” lists, but investors who get in on these hot funds too late, tend to lose out.
Winners in one year, tend to end up as losers in later years. According to Mark Hulbert in a recent MarketWatch article, the best thing you can do is "sit on your hands."
However, you can also find opportunities to get rich by avoiding performance-chasing investor mistakes and opt for a market-matching index fund investing approach. In a Vanguard study of 2,202 actively managed funds in 2001, only 476 of them outperformed the indexes during the next 15 years. Another source says that index fund investing beats active management investing strategies most of the time!
Buy When Other Investors Are Sellers
Investors are driven by fear and greed. After a market decline, many investors get scared and make the mistake of selling. That’s a losing strategy as investors are locking in their losses. Then, after the markets rebound, these same folks will jump back in near the next market peak. This behavior translates into the average long-term investor earning just 3.79 percent and the S&P 500 earning close to 10.00 percent.
You can take advantage of investor fear and greed when they sell after market drops and buy close to market peaks. The way to get rich from these irrational investor mistakes is two-fold: First, pick an investing strategy and stick with it.
Next, when markets are in the doldrums, pick up extra shares and hold to profit during the next bull market.
To profit from market inefficiencies and other investors mistakes, don’t be swayed by the hype. Avoid crowd-think and chasing returns. When investing, cool heads prevail and prosper.
Barbara A. Friedberg is a former portfolio manager and university investments instructor. Her writing appears on various websites including Robo-Advisor Pros.com and Barbara Friedberg Personal Finance.