ChuckJaffe

BOSTON (MarketWatch) — There’s a simple lesson for mutual fund investors traveling the stock market’s wild road these days: Pick a lane.

The drivers who can’t decide if they are going to be traders or investors — the ones who are weaving and cutting in and out or riding the center line taking up space in all lanes — they’re acting like they don’t know where they are going or how to get there.

To modify an old market axiom: traders make money, investors make money, but wafflers get run over. Read more: How to cope with market turmoil.

Added Donald MacGregor of MacGregor-Bates Inc. which studies investor behavior and decision-making: “If you are a real, seasoned trader, this is a good time to be active because there are some real opportunities out there for you right now. If you are an investor and you have your portfolio where you like how you set it up, this is a good time to decide if you really are a long-game player.

Pick a lane, stick with strategy

Investors often adopt a strategy and then make sudden changes, says MarketWatch columnist Chuck Jaffe, who adds that holding cash gives flexibility in volatile markets. Image courtesy of AP.

“And if you always thought you were an investor, but you’ve been watching the news and think it might be time to start making trades,” he added, “good luck to you because there are at least as many opportunities to make mistakes as to make money.”

Studies on investor behavior show that the typical fund shareowner gets performance that is much worse than the fund itself. The reason for that is simple: The average investor only buys a fund after a stretch of good performance and sells it on the first big downturn, thus buying high and selling low rather than staying on the path they are on and riding through the ups and downs to reach their long-term goal.

Those kind of classic mistakes are made in times like these, when volatility makes the market scary enough that investors act on impulse, either trying to protect themselves or thinking they could do better by trading.

“There are a lot of people who are looking at what their funds have done this year or over the last few years, and they see it as being flat and are thinking ‘That’s not working, so I have to play the game,” said Dr. Richard Peterson of MarketPsych Data in Santa Monica, Calif. “Maybe they are expecting 5% out of their funds in a year, and now they see the market moving 5% in a day and they think ‘If I can capture that one day right now, I’d be set for the entire year.’ But they don’t capture it and they don’t just make one trade, they are sliding from investor to trader, and that’s not what the average person should do right now.”

What most behavioral finance experts suggest for average investors is that they reassess their risk tolerance and come up with a strategy for what to do when the markets, seemingly, go crazy.

University of California at Berkeley professor Terrance Odean noted that most financial advisers and investors look at funds in terms of how much loss they can withstand, as in “Could you stomach a loss of 20% in this fund?” That kind of thinking assumes that investors face a loss of 20% and no more.

“The real problem comes up when you are down, say, 15% and you don’t know what is going to happen next, but you realize that the only one who capped the fund’s downturn at 20% was you, and that was only in your head,” Odean said.

In short, every investor is a tough guy, right up to the moment where the market punches them in the face.

“If you don’t have a strategy for what you should do when the market goes crazy, then you need to look at whether you have any strategy at all right now,” Odean said. “You need to say ‘Given my current portfolio, will I be able to stick with my plan when things get worse from where they are now?’ Then get yourself to a plan that you will be able to live with, because while most investors like the idea of trading, they’re not very good at it, and leaving your portfolio in the hands of a bad trader — you — is almost always worse than leaving your portfolio in place for the long haul.”