The Ways In Which Contrary Thinking Is Great For Investors

by David Jenyns on January 31, 2012

In simple language, the best investment results require the art of contrary thinking. It is advantageous to be contrary. Speculating with the herd only gets you mixed up in financial manias and bubbles. Human nature is what causes us to repeat the thoughts and actions of others. Regardless of the accomplishments in computers, human psychology has remained the same. Due to this, we continue to have the economic cycle which isn’t different today than what it has been through history.

It makes no sense to replicate what everyone else is doing when it comes to speculating. If everybody is chasing a single asset class, that investment must be unrealistically priced. When everybody was purchasing dot com stocks, other assets, including precious medals and other commodities, were seldom discussed. This demonstrates that the best time to get an investment is when no one is talking about it.

Over the course of time, these cycles repeat. A bull market begins when savvy investors begin buying an investment that’s unpopular and has been forgotten about. The first part of a bull market flies below the wire and gets almost no media attention. As that asset sector gets more traction and finally shows a past history of rising prices, it draws more backers and more media interest.

Eventually, a 3rd stage happens. The real bubble begins once that asset price has passed it’s fair value yet speculators keep pouring cash into it. You see magazine covers showing it off and it’s on CNBC all day. When that happens, it’s a bubble and you need to lay off of it. The day of reckoning will eventually come and the price of that asset will usually drop by 70% or more.

If you’re like the majority of people, reflect back at your past experience with mutual funds. As the old saying goes, funds do really well until you put your very own money into them. This is almost always the case among the best performing funds. This is due to the fact that a mutual fund’s holdings are in that 3rd stage when you purchase it. Otherwise, it wouldn’t have had the history of being a top performer.

A fund that’s got a great ten-year track record most likely holds investments that were undervalued when the fund chief first bought them. Over time, they kept going up in price till they were overvalued. At that point, those funds are featured in every magazine, on each financial website, and on television. If you decide to buy that fund, you either think it can continue going up while keeping the same investments. Or, you believe the fund chief is smart enough to trade one set of assets and invest in another at the perfect time. History shows this is highly doubtful.

One of the most exasperating things is knowing when a bubble has peaked. When you get to a point at which prices apparently could not go any higher, they double. This is usually how it happens. Meanwhile, you hear from friends and family who allege they’re making lots of cash. And you realize you’re squandering your breath by describing that a bubble is getting ready to burst. At the same time, you do not have 100% confidence in your own judgment and are almost convinced to jump in yourself. Prices never get so high to the point at which they can not go higher. On the same law, no boom ever eludes a bust.

If only it were that easy to buy low and sell high. It’s such a simple idea yet so few can put it to practice.

Eileen Jacobs is a tax accountant from Las Vegas. For more on contrary thinking with investing, view Eileen Jacobs Investing Blog


Previous post:

Next post: