Choosing the Road Less Traveled
Can Be a Smart Investing Strategy

I shall be telling this with a sigh

Somewhere ages and ages hence:

Two roads diverged in a wood, and I—

I took the one less traveled by,

And that has made all the difference.

—Robert Frost, “The Road Not Taken”

The September 29, 2010 issue of The Wall Street Journal featured an article entitled “You Should Have Timed the Market” by Brett Arends. The article discusses a recent study conducted by TrimTabs Investment Research that found investors collectively lost approximately $39 billion over the past decade. Why? Investors yielded to the “herd mentality.” They traveled down the road of investing additional capital in equity mutual funds at the highs and subsequently selling in panic at the lows.

“Human beings are hard-wired to run with the herd,” notes Arends. “For millions of years, when the herd stampeded, the smartest move wasn’t [to] hang around and wait to see why. It was to run. And that’s how [humans] act on the stock market as well. But when it comes to investing, it’s a bad idea. Your feelings are a bad guide. And there is no safety in numbers.”

An often cited investing adage is “buy low, sell high.” Interestingly enough, the TrimTabs study calculated that mutual fund investors bought into the S&P 500 Index at an average level of 1,434 (very close to the index’s record high of 1,565). Vincent Deluard, executive vice president of research at TrimTabs, estimated that the folly of buying high and selling low cost these investors roughly 20% of their investable assets.

Conversely, investors should consider using an investment strategy known as dollar-cost averaging to alleviate market risk. This technique involves buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high. This allows investors to attain a lower average cost per share of the investment over time. Dollar-cost averaging lessens the risk of investing a large amount in a single investment at the most inopportune time.

If investors had used dollar-cost averaging, their average purchase price would have been 1,171 on the S&P 500 Index (22.5% lower than the average 1,434 level cited in the study), according to Arends. When confronted with two diverging roads, TrimTabs research revealed that the smartest move was actually to choose the path less traveled. “All you had to do was buy when the public was selling, and sell when the public was buying,” says Arends.