Remember when the Carnival of Wealth was hosted by Arohan of Personal Dividends? He was the Jack Paar to our Johnny Carson. The Al Atkins to our Rob Halford. The Blue Ribbon Sports to our Nike.

After handing off control of the CoW to us, Arohan took off the superhero mask and identified himself as Shailesh Kumar. He now runs Value Stock Guide, where he admits to a long history of antisocial behavior (at least when it comes to investing in stocks.) And he wrote today’s post. Subscribe to Shailesh’s newsletter, if you can handle no-frills stock advice. Or not. It’s your money after all, we don’t really care.

Investors are a fickle bunch. They move in and out of stocks for reasons that have not much to do with the business fundamentals. The general perception of the economy and the expectations of the future stock market returns define how most investors behave. Unfortunately, they generally do the very thing they should not be doing and don’t do the thing they should be, exacerbating the boom-and-bust cycles the stock market continues to go through.

This may sound strange, coming from a value investor who mostly relies on company fundamentals to find value stock picks. (Value investors tend to have their heads in the sand and ignore the behavioralists as quacks.) But the general economic sentiment changes investor behavior in a way that has a detrimental effect on their portfolio performance.

The Feel Good Bubble

“Irrational Exuberance” is how Alan Greenspan described it. This period is characterized by a climbing stock market, strong real estate sector, low unemployment rate, high consumer spending and a general feeling of financial security that leads people to believe that the good times are here to stay and they can continue to binge on their credit. This is also the time when most investors are brainwashed into thinking “this time it is different” by the media and the pundits (who generally have a vested interest in seeing that the bubble continues as long as it can). So rising stocks rise faster as investors throw caution (and investing common sense) to the wind, and pile on.

Unfortunately, more and new investors are also drawn into the market with the lure of quick profits, when they see the Joneses buying new toys that no longer fit in their garages and vacationing in far-away dreamy lands.

The result is that when the bubble bursts, most people end up with assets bought at high prices, overextended credit, dysfunctional marriages and gloomy job prospects.

The Economic and Investment Recession

The inverse of irrational exuberance is, of course, rational pessimism that changes the hitherto rose-colored lenses to dark gray. It is perverse that at the times when opportunities abound, humans have the uncanny ability to turn inward and refuse to answer the knocks on the door. Making matters worse, the scars of investments gone sour so affect the psyche that these investors continue to pull out of their investments at the most inopportune times.

It is as if the herd has unanimously decided to fall off the cliff. Investors lose the ability to look around and make a rational decision about the environment they find themselves in. Their complete focus is on getting out before it’s too late.

It’s already too late.

When the cycle bottoms out, most people end up with assets in cash and under the mattress, with their investments sold at low prices. If they have exercised better sense in other areas of their lives, perhaps their marital bonds are stronger and they have made the effort to pay down their credit debt.

Break Out from the Herd If You Want to Profit

The basic premise of successful investing is “buy low and sell high”. Common sense, right? In reality, it is really, really hard to do. As soon as you let your emotions, hopes, and fears rule your investment decisions, you lose. If you give in to your inbuilt urge to be seen doing the same things that you see others doing, you lose. You need to detach yourself from these blocks and social niceties and start making investment decisions on their merit.

Unlike other financial bloggers who will list 101 tips to investment success, I will only give you 2:

• Sell on the high – When the markets are high, or your stocks have gone up beyond your judgment of their value, sell. Ignore all the voices on the TV, around the water cooler, and in your head that keep telling you that the stock will go higher. So what if you lose out on a few more percentage points of appreciation? Real money is not made on your sale price. Real money is made at the price you buy the stock. When the asset tops out, you want to be in the cash, not invested in the asset.
• Buy on the low – If you believe that things can’t get any worse, and that the world is coming to an end, then know that you are not the only one who believes this. The weak hands have already sold or will do so soon. Investors who are still holding are doing so for more fundamental reasons. If you have been practicing the “Sell on the high” concept, you have cash to invest. This is the time to choose which stocks you would like to buy. Choose wisely – this will determine your returns.

There is no precedence of the world ending in the history of mankind, as far as I know.

Breaking out from the herd is hard to do at first. But once you do it and see the results, you will be able to give that “knowing smile” to the poor saps who dole out stock tips from the bar stool. Not that you will hang out with them any more.