Investor "Acrophobia" 

Berkshire Hathaway's Warren Buffett at the company's annual meeting in Omaha. Photograph by Daniel Acker/Bloomberg Close

Berkshire Hathaway's Warren Buffett at the company's annual meeting in... Read More

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Berkshire Hathaway's Warren Buffett at the company's annual meeting in Omaha. Photograph by Daniel Acker/Bloomberg

March 8, 2013 - For many investors, the news that the Dow Jones Industrial Average is hitting records triggers what John Buckingham, chief investment officer at Al Frank Asset Management, calls "acrophobia" -- a fear of heights.

Don’t get rattled, says Warren Buffett. The 82-year-old billionaire notes the Dow rose 17,320 percent in the 20th century despite four big wars and a Great Depression. "Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor," Buffett says in his latest letter to Berkshire Hathaway shareholders.

“It’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of ‘experts,’ or the ebb and flow of business activity,” Buffett adds. “The risks of being out of the game are huge compared to the risks of being in it."

Is this timeless advice -- or a dated outlook? Experts at the firm Research Affiliates say Buffett's "buy-and-hold" philosophy is passė. “Investors would be wise to bank some of their outsized 2012 gains,” Research Affiliates’ John West concludes. He argues good investing, like good batting in baseball, is about waiting for the perfect pitch. If investors swing at everything -- i.e., stay fully invested in stocks at all times -- they’ll do worse than a more selective approach.

The rub: Investors are terrible at waiting for the right pitch, a fact proven again and again by experts in the hot field of behavioral economics. Data show people who trade into and out of the market consistently buy high and sell low.

Moreover, if your only Plan B is to take profits and put recent gains in your bank account or under the proverbial mattress, Greg Davies, head of behavioral and quantitative finance at Barclays Wealth, says you're making a psychological error called "reluctance" that has a direct effect on your returns. Holding cash may be safe, but it costs investors 4 to 5 percent per year of foregone returns, he calculates. Davies dubs the results of all this self-defeating behavior “anxiety-induced returns.”

If records still make you nervous, you might reassure yourself with the fact that the Dow Jones Industrial Average is still 11.5 percent below its all-time high -- when adjusted for inflation.

This essay originally appeared in Bloomberg.com's weekly personal finance newsletter, Wealth Watch. Sign up here.

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