Imagine that you're smart and honest. Imagine that you don't know anything about investing… and then imagine that you're smart and honest enough to admit it.
So, you follow the advice of more skilled investors and invest the bulk of your wealth in low-cost exchanged traded funds (ETFs) like ISCS&P500 CDI 1:1 (ASX: IVV), ISGLHLTCA CDI 1:1 (ASX: IXJ), and ETFSOZI ETF UNITS (ASX: ZOZI) which track the US S&P 500 Index, The Global Healthcare index, and the ASX100 Index respectively.
They cost less than 0.5% per annum in management fees, and over the last five years you've done well. You lag the market, very slightly, but you beat the vast majority of professional investors, smash the performance of your friends buying speculative stocks like Resapp Health Ltd (ASX: RAP), and look enviously at your other friends who bought Bitcoin in 2012 and have now retired in the Bahamas.
You buy some Commonwealth Bank of Australia (ASX: CBA), and maybe some CSL Limited (ASX: CSL) too because you've heard it's the best company on the ASX. Then, after five years in which shares prices only go up and your wealth grows quickly, you make your first mistake.
"This is pretty easy," you think.
Three seconds later, the market collapses. You are down 30%, and over the next six months as investors around the globe panic and sell their ETFs, shares tumble a further 30%.
(Remember, ETFs are just a 'vehicle' that own shares directly. When lots of people sell their units in the ETFs, the ETFs must sell the shares that they hold, which can push prices down further. People then see prices falling, and more people sell their ETF holdings, sparking even more selling.)
You are now down 51% and headlines are screaming doom.
ETF Sellers Capitulate, $500 Billion Sold in July Alone!
ETFs a 'ticking time bomb!' says Prominent Investment Analyst
At the absolute nadir when everything looks black, the icy fingers of fear grip your heart and you sell your ETFs too, delighted and grateful to have limited your losses to 51%.
(This is probably about a loss of 30% of your capital once you account for the growth you achieved.)
Despite all your hard work and discipline at investing regularly, you've been brought undone by your own psychology, which was not prepared for the truism that all markets have panics periodically.
It is really easy to buy shares and ETFs. The hard part is holding them, especially in times of a market collapse. Yet ironically, market collapses are the best time to invest even more, as this chart of the ASX200 index shows:
Investors who had the courage to buy index funds in late 2008 or early 2009, have seen quite satisfactory results, even accounting for the fact that the ASX is a mediocre index. Those who bought the US S&P 500 or the NASDAQ have done extraordinarily well.
Sadly however, our hypothetical investor in the above story didn't know that.
"Screw this." they say. "Shares suck. I'm going to buy Bitcoin."
