I read an article in the Investor’s Business Daily about an investment strategy with an interesting twist using country ETFs. In a nutshell, this approach calls for buying those country ETFs with the worst news rather than the best. No it’s not a strategy created by people who love to lose money. Quite the opposite. But before we go any further I want to make one thing clear. Even if you never plan on buying an ETF (let alone a country ETF) this strategy can help you become a much better investor. Let’s take a closer look.
Background
As you may know, an ETF is a type of index fund. A country ETF buys and holds stocks that represent the overall economic strength of a given country.
This particular strategy is built around behavioral economics. The idea is to gauge broad economic sentiment, interpret the results and then trade stocks accordingly. The surprising conclusion was that extremely negative sentiment can be a great buying opportunity.
In other words, buying country ETFs with the worst sentiment and selling short those country ETFs with the most positive sentiment led to extremely high investment returns (according to the study they reported on).
Why This Works
The article pointed out that humans view situations in black and white. When things are bad we convince ourselves that they are terrible, catastrophic and beyond all repair. When things are good we can’t see anything but blue skies ahead. I don’t know about you but this sounds about right to me.
We often think about events that are highly unlikely to occur but we behave as though they are inevitable. When we do that we panic and behave irrationally. This investment approach suggests that you identify these kinds of events and bet against that irrational behavior.
Should You Use This Investment Strategy?
I haven’t seen enough results to evaluate if this is a good investment approach or not. Most important, I like to see how poorly a given strategy does in bad years so I get a sense of how painful the bad times just might be. I’m not suggesting you use this specific approach but I still think the research these people have done can be a priceless tool.
How To Use This Concept
This research proves that our feelings aren’t very good indicators of true risk. Let me give you an example. According to the article, Pakistan was touted as a buying opportunity at the time the article was written. Now if you are like me you probably lose your lunch at the thought of investing in Pakistan right now. And that gut reaction proves the point.
Most investors have the reaction you and I do and that floods the market with sellers. Frenzied selling ensues and prices drop to unreasonable levels. When that happens opportunity raises its lovely head.
The flip side of this is equally important if you want to avoid losing a fortune. In September of 2011 gold hit an all-time high of over $1900 an ounce. About that same time every body and their uncle wanted in. Investor sentiment was absolutely giddy for gold. I know because I took those phone calls. But in the 2 years since, the price has plummeted 35%. Of course gold isn’t the only bubble that has burst leaving investors holding the bag. Real estate, tech stocks, Apple Shares…you name it. There are plenty of examples.
Bottom line? Use an investment strategy that fits you well and stick to it. With all the strength at your command resist acquiescing to your emotions. If history is any guide, this won’t be easy Human nature is formidable. But if you want to grow your assets safely, keep in mind that your feelings are not facts – and they can be extremely expensive.
Do you invest based on your feelings? How has it worked out over the long-term?
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