Financial Planning Fridays #31: Don’t Invest Like Your Neighbors

In our 31st Financial Planning Friday’s episode I wanted to discuss why it is so important not to
take the same investment approach that many of your neighbors are using.

The American Association of Individual Investors is a non-profit organization that has completed a weekly survey since 1987 where they ask a simple question, Do you feel the direction of the stock market over the next six months will be up (bullish), no change (neutral) or down (bearish)?

We looked at the results of that survey and then compared them to the return of the S&P 500 the year afterwards. How accurate are your neighbors at predicting which way the market will move next? Let’s look at the data together.

We put together the five worst average bull/bear spread years since they started the survey 35 years ago. These are the years where investors were feeling most pessimistic about the market for the next six months. The returns listed above each of those years is the market return the year after those surveys. The S&P 500 averaged more than 24% the year after when the survey respondents were most pessimistic. All five times the annual return was positive and every year had a return that was well above the average long-term return.

Next we reviewed the years when investors were most optimistic about the market instead. In the years following the five most optimistic average survey years, the average return was only 4.6% per year and two of the five years were negative. This is about 19% lower than the years after investors were most pessimistic. This survey tells us that the market has outperformed in the years after especially pessimistic investor sentiment surveys and underperformed in the years after optimistic investor surveys!

Warren Buffet has said to “be fearful when others are greedy, and greedy when others are fearful.” This has certainly proved true over the past 35 years of this survey. And this is especially relevant today – the most pessimistic average year for the bull/bear spread in that survey was last year.

I don’t know what the full-year 2023 will bring but looking at the previous results when investors have been this pessimistic gives me another reason for optimism.

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