What exactly is contrarian investing?
There are some people that, for whatever reason, are just drawn to being a little different than everyone else. Something about it just feels right to them. They’re constantly questioning authority and conventional wisdom. Rather than blinding accepting what’s presented as fact, these people will prove it for themselves. As the cliche goes, they march to the beat of a different drummer.
Welcome to the world of the contrarian. As a card-carrying member, I invite you to grab a beverage and spend a little while reading what we’re all about. You’ll probably think that us contrarians are a little weird. It’s fine, we do point and laugh at you and your blind faith in following the crowd.
Being that we’re on a financial site, let’s keep the conversation focused on money topics, specifically investments. You might think a contrarian is one of those guys who always think the market is going to go down. Humans are generally pretty optimistic, so someone who constantly predicts doom would have a differing opinion most of the time. Being contrarian is a little more complicated than that.
Yes, often contrarian investors will predict a market sell-off, particularly when the rest of the world is bullish. The main identifier of a contrarian investor is the ability to pick their spots to go against the heard.
Let’s take, as an example, the European debt crisis. I think, like a large portion of the investing population, that it isn’t going to end well. I also think the ripple effects of that will affect most of the industrialized world. It’s a pretty standard opinion. Saying that though, I think the price of gold already has a European crisis already factored in, so gold is a pretty bad place to be going forward.
There are other contrarians investing myths too. We don’t just pick stocks or investments that are simply out of favor. There are all sorts of reasons why a stock could sell-off. Painstaking research is applied to determine whether the company in question can actually return to former glory, or whether the company will be left to wander aimlessly like a zombie.
Ultimately though, even after hours of research, trying to predict a turnaround is still an inexact science. This doesn’t bother contrarians, since they look for investing home runs, instead of singles. If one company triples or quadruples in value, it easily makes up for the dog of the portfolio that fell 75%. Remember, a stock can only fall 100%, but can go up much more than that.
Becoming a contrarian investor
There are essentially two ways of becoming a contrarian investor. You can either pick individual stocks or pick whole sectors that are beaten up.
Take, for example, American banks. Over the past few years, they’ve had to deal with a mortgage crisis, a liquidity crisis, a bailout just to keep them alive, a cap on some banking fees, as well as general economic weakness. It is not a good time to be an American bank. The share prices of these institutions have fallen sharply from their highs in 2008. To participate in recovery you could either do a bunch of research and try to find the best of the bunch, or just find an exchange-traded fund that tracks the sector. You’ve just knocked your risk down considerably by investing in every company in the sector, but in exchange for knowing you’ve capped your return by spreading out the risk. Or you could buy Bank of America, thinking that it will outperform the others in the sector.
If you’re committed to picking individual stocks, be prepared to spend a lot of time using stock screeners and reading annual reports. The contrarian investor is looking for something that represents a catalyst for change. It might be a new CEO, or the introduction of a new product, or anything in between. Knowing that significant changes can take years to turn a company around, a contrarian is prepared to hold investments for a long time. The contrarian knows that there is a risk of the company eventually going bankrupt as well, but is willing to make that trade-off.
Should you be a contrarian
Of course, you should. We’re always happy to welcome new members into our little club.
If you can’t wrap your head around the idea of going against the masses, you’re not going to make a very good contrarian. Being contrarian will involve things like having an argument with a friend of a friend about the long term viability of Netflix because you just can’t help yourself. It’s kind of a lonely existence.
Taking the concept a little larger, being a contrarian in your life isn’t such a bad thing. Instead of blinding believing societal norms like you should always have a car payment or you should get married by the time you hit 30, take a little time and think about whether they’re right for you. Independent thought is good. Sometimes us contrarians can be guilty of taking it too far; we think too far outside the box. Which is worse- thinking too far outside the box? Or failing to leave the box in the first place?