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The problem with 'buy low, sell high' advice for investors

Among the many common words of wisdom in the finance industry, undoubtedly the most popular is, "Buy low and sell high." While it sounds simple enough, it's actually significantly more complex than it seems.

Buying low comes from an investment philosophy known as value investing. The basic concept of value investing is to buy investment instruments when they are "on sale." That means buying when everyone else is selling (and prices are down) and vice versa.

American flags fly outside The New York Stock Exchange in New York.
Michael Nagle | Bloomberg | Getty Images

A bargain-hunting value investor looks for what they consider to be healthy companies that are — for whatever reason — severely undervalued. A smart value investor buys low, then patiently waits for the "herd" to catch up. Unfortunately, most investors tend to do the exact opposite. We tend to chase trends and follow the herd.

A huge part of smart investing is psychological. We may want to buy low and sell high, but that goes against our instincts and biases.

When a stock is falling, we dump it. When a stock is rising, we buy it. We sell a company when the price is falling, because we are afraid of losing more money; we buy a stock when it is rising because we have a fear of missing out. To compound the problem, most investors are not experts at realizing when something is high or low "enough."

At times investing can feel like quicksand: The more you do and the harder you try, the more you sink. It requires effort to overcome the psychological biases that often prevent us from acting in our own best interest. It is human nature, for instance, to continue to make the same mistake over and over again or to not let go of stocks when we should, through either familiarity bias or disposition effect.

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So what can you do to avoid the pitfalls of trying to buy low and sell high?

  1. Understand your goals and risk tolerance. Before you start investing, it is critically important to understand what it is you are trying to accomplish and how much risk you are comfortable taking. Once you have that figured out, you can create an investment plan that is appropriate for you and comfortable enough to keep you from impulse-buying high and panic-selling low.
  2. Avoid market timing. Instead of trying to time investments perfectly and squeeze every last cent out of each one, focus on building a diversified portfolio of stocks and bonds that give you the greatest chance to succeed over the long term.
  3. Leverage your resources. Having a great financial plan and a diversified portfolio is irrelevant if you don't follow through and stick to it. Becoming self-aware of the pitfalls is a great first step. Having a good financial advisor is a good step, too. Just make sure they are a fee-only fiduciary so that they have your best interests in mind at all times.

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Think about it: If it were easy, if everyone bought low and sold high, there would be no high or low, because the market prices would be continually correcting. Bargains do exist, and sometimes the wisest choice is to lock in earnings.

The safest financial plan for the long run, however, is to understand your goals and risk tolerance, then work to create an investment plan that builds on gains over the long term rather than continually outguess the market.

(Editor's note: This guest column originally appeared on Investopedia.)

— By Brad Sherman, president of Sherman Wealth Management