The reasons are numerous but here are two of the psychological reasons. ‘Scarcity’ and ‘social proof’ are steering us to buy high, and sell low. In this case, we are our own worst enemies. Buying low and sell high seems easy understand and follow. Yet most of us are unable to keep this simple rule straight in our heads when it comes to the stock market, including the people managing your money. Our instinct tells us to buy stocks when prices are high and to sell stocks when prices are low. Why?!! There are two key reasons for this –social proof and scarcity.
It is human nature to look to others to determine the best course of action for ourselves. If we look outside and see people wearing shorts, we assume that the weather is warm and will switch to wearing shorts. If we see cars ahead start to change lanes, we will try to change lanes as well, in anticipation of an upcoming road block or accident.
If we are led to ‘believe’ others are getting rich by risking their money, then it must be the thing to do. Key word, “believe”. The same goes for when everyone else is selling. We think we should sell too. Social proof alone however, does not create such a strong effect that we always contrary to our own interests. There other key force at play is scarcity. In his book INFLUENCE, scarcity is the last of six weapons of influence described by Robert Cialdini. It was probably saved for last because of the strength of its effects.
We all have a natural tendency to want things that are in short supply. We think that cookies taste better when we are only given two, compared to ten. Similarly, we (your advisor too) will rush in and buy stocks at $10 because we are afraid that in a short time they will only be available for $12, $15, or much more. We must buy it now, because this price may not be available for much longer. That is why when the stock market is rising, we (and your advisor) feels a great need to jump in and buy, buy, buy.
As the market rises, stocks at lower prices become more and more scarce, which creates more buying, which makes them more scarce, and on and on it goes until the music stops. Alan Greenspan calls it, “Irrational exuberance.”
I think we have all experienced this, many times; in all areas of our life. We appreciate something most after losing it. Lovers, our freedoms, a chocolate chip cookie, and yes definitely, also money. We like making money, but we hate losing money a lot more. That is why when there is a large drop in the stock market and we have lost a lot of money, we are shy about buying more. Once we have lost, we want to hold on to what we have for fear of losing more.
This makes us most likely to buy when prices are high, because we have lost nothing and have gained much (at least on paper). Similarly, we are likely to sell or at the very least, not buy, when prices are low.
The other aspect of scarcity has to do with competition. And as we all know, competition is the cornerstone of the stock market. When prices are high, we are most compelled to buy because that is the time when there is most competition for a stock. We must get it now before someone else gets it and makes money that should be ours. When prices are low, we are compelled to sell because we do not want to lose the opportunity of getting rid of our crap to someone else. Buying high and selling low will devastate a retirement strategy that depends upon assets tied to market volatility.