For almost 150 years, Pennsylvanians have gathered at Gobblers Knob in Punxsutawney to find out whether we’ll suffer through six more weeks of winter. The rodent meteorologist they wait to hear from is none other than Pennsylvania’s most famous groundhog, Punxsutawney Phil.
For many non-PA residents, “Groundhog Day” may conjure up memories of the movie by the same name. In it, Bill Murray’s Character (news reporter Phil Connors) is forced to wake up to the same February 2nd over and over again. Like Bill Murray’s futile attempts at breaking the inane cycle of reliving the same day in Punxsutawney, investors often fall prey to an equally discouraging cycle of investing.
Groundhog Day Investing
“Groundhog Day” investors fail to break the emotionally driven cycle of chasing “hot” investments, buying high and selling low and over-concentration in a single market sector. Ironically, this investment philosophy of throwing money in one direction, and hoping to hit a jackpot, aligns more closely with that of Pennsylvania’s second most famous groundhog, Gus. I know, that’s a lot of groundhog references, so if you’re wondering where I’m going with this, just keep on scratching… I mean, reading!
Consider the example of professional athletes in recent years announcing that they will begin to accept a portion of their salary in Bitcoin. Depending on your opinion of cryptocurrencies, this may seem like a savvy move. Bitcoin has certainly been a “hot” investment, and seems to be gaining “staying” power as a digital currency.
A 2021 MarketWatch article specifically highlights the announcement of the NFL’s Odell Beckham Jr. At the time of his announcement, Bitcoin’s price was hovering around $65,000. More recently, it has dropped below $20,000. Had Beckham taken the reported $750,000 portion of his salary in a lump sum on the day of his announcement, it would have dwindled to a mere $230,000. It gets worse. After accounting for Federal and California state taxes (on the original salary of $750,000), Beckham would actually end up with a net deficit!
I can’t tell you if the above scenario actually played out as described, but it does offer a compelling example of the “Groundhog Day” investing approach. An approach of lump sum, concentrated investing into “hot”, volatile or speculative markets.
Dollar Cost Averaging
A strategy that counteracts some of these Groundhog Day investing pitfalls is dollar cost averaging (DCA). DCA is simply spreading out investment contributions over time rather than investing all at once. Many investors do this already, without even realizing it, by funding a savings account or 401(k) on a monthly basis.
DCA allows investors to “buy” into the market without the fear of bad timing as some contributions will inevitably coincide with market highs, and others coincide with lows.
Rebalancing
Even with DCA, though, funds in an investment portfolio grow at different rates. This inevitably leads to over/under-concentration of investments above or below “target” allocations. Rebalancing accounts sells some of the high flyers and uses the proceeds to buy back into the lower performers. This alleviates asset concentration and brings the portfolio’s target allocation back into alignment.
It also effectively ensures a “buy low sell high” strategy. In down markets, buying some of the more aggressive funds that have declined, positions the portfolio to respond better once market trends change.
Diversity
You might be thinking that simply eliminating these underperforming investments would be the best approach. If there was a way to consistently predict which areas of the market will outperform, this would be a fantastic idea. Unfortunately, even professional “active” fund managers are unable to accomplish this.
In 2020, for example, REITS (Real Estate Investment Trusts) were one of the worst performing market sectors. In 2021, they were one of the best. Last year, they fell to the bottom again. This unpredictability highlights the importance of diversity. Since we don’t know which sectors will be winners from one year to the next, investing in a diverse selection of market sectors creates the opportunity for reduced volatility, lower risk and higher exposure to growth.
Whether we experience six more weeks of winter or enjoy an early spring won’t result from Punxsutawney Phil’s meteorological crystal ball. Having enough money saved for your dream vacation, next major purchase or retirement won’t result from trying to get rich quick – no matter how much you keep scratching. Investment success culminates from developing an investment plan and staying disciplined in following it. Dollar cost averaging into a diversified portfolio with periodic rebalancing are ways to avoid “Groundhog Day” investing.
