Friday, July 29, 2011

How fear and loathing can mess up your retirement investment strategy

“Individuals who cannot master their emotions are ill-suited to profit from the investment process.” -- Benjamin Graham, American economist and professional investor.

Away for the past week on a river raft float trip in Idaho, I was hopeful that by the time I returned the debt debate in Congress would be resolved. How foolish I was.
Throughout my newspaper career I lived with sometimes hourly deadlines to get stories reported, written and in print or on the Web site for readers. I've lived with weekly deadlines for my business news column and bigger deadlines for in-depth reports that must be coordinated with photos and graphics. So I know about deadlines. And I know about human nature.
Given any wiggle room, we take it..... just as Congress is going up to the wire (if not beyond) on raising the nation's debt ceiling. We hate the turmoil, confusion and fear that are coming out of this debate. But I see the process as a good one even if it makes us all crazy and gives the Chinese reason to point out how messy democracy can be and how their autocratic top-down system would have resolved all this months ago.
Managing our fear as investors
Having said this, fear in the face of seeming chaos is something we investors must manage. We all have biases against losing money, losing investment value in our nest eggs and 401(k)s. But making hasty decisions out of emotion and fear can be regrettable, experts who study this stuff, say.
Recognizing our innate biases "may help prevent investors from tampering with a well-crafted portfolio strategy during periods of severe market turmoil," say the writers at Fidelity Viewpoints at http://www.fidelity.com./
"Some investors, including both individuals and professionals alike, have been prone to altering well-thought-out investment plans during such periods of heightened financial market turmoil," they say.
It turns out that our brains are wired to avoid risk and loss over generations of human evolution. When the hungry saber-tooth tiger is chasing you the best strategy is to get the heck away from him.. That  makes sense in the jungle but not in investment markets. According to research by psychologists Daniel Kahneman and Amos Tversky, we tend to respond more dramatically to potential investment losses than we do to possible gains. "The strong influence of loss aversion helps explain why many investors disregard predetermined investment strategies when unforeseen, negative events occur," Fidelity experts add. "Such events fuel our fears of incurring losses, and cause an internal battle to break out between the logical side of our brains and the emotionally driven side, the latter of which often prevails."
So what's the message? Stick with your investment plan even as Congress does its best to create the impression that our world is about to end. Ride it down, then be prepared to ride it up. Spread your risk across several investment categories and remain patient.
Moving to the sidelines
Selling often leaves us on the sidelines when things turn around. My own experience would be selling a stock growth mutual fund in 2001 after it had taken a beating and putting the money into CDs, which produced small returns compared to the turnaround in the fund's value a few years later.
According to Fidelity research, investors who bailed out of equity markets in the fall of 2008 at the peak of the global financial crisis lost out on a overall 16 percent rally by June of 2010.
"Because only a fraction of the massive outflows seen during the fourth quarter of 2008 and in early 2009 trickled back into equity funds throughout the subsequently robust 2009 rally, market-timing investors had either missed the market’s abrupt turnaround or reentered the market at higher price levels." said Fidelity.
On the other hand, investors who stuck with stocks fared better. (Using the monthly average index level for the S&P 500 Index, the index’s total return from October 2008 through June 2010 was 16.4 percent. From the beginning of October 2008 to the end of June 2010, the Ibbotson Associates SBBI U.S. 30-day Treasury Bill Index returned 0.056 percent. Source: Ibbotson Associates, FMRCo)
Bottom line: Periods of turmoil are not unusual. This one only seems that way because of over-coverage and confusing comment from the national media.
So how are you doing through this latest "crisis?"
Can you take it when things seem headed downhill?
Will your thinking brain win out over your emotional brain or as a friend of mine, Dr. Al Bernstein, calls it, your "Dinosaur Brain," which keeps telling you to run for the hills?
The experts at Fidelity say your investment decisions "should be based on your individual goals, time horizon, and tolerance for risk. "Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money," they say.
When is it time to buy? According to Peter Lynch, author of "One Up on Wall Street," the time to buy is "during the collapses, drops, burps, hiccups and freefalls that occur in the stock market every few years." Look at solid companies with excellent earnings growth, he advises. Good hunting.
More on investment strategies:
1. Loss aversion psychology is based studies first introduced by psychologists Daniel Kahneman and Amos Tversky in a 1979 article, "Prospect Theory: An Analysis of Decision Under Risk," that ran in Econometrica, an academic journal of economics. Kahneman was awarded the Nobel Prize in Economics in 2002, largely for his body of work in conjunction with Tversky that contributed to the field of study known as Behavioral Economics, and its related area of study, Behavioral Finance.
2. "The Little Book of Behavioral Investing," by James Montier, John Wiley & Sons, 2010. ($19.95 at Powells.com
3. "Risk Aversion Investment Strategy," at pennysleuth.com.
4.Risk aversion defined at investorwords.com.
5. Join the debt debate at the Wall Street Journal's blog site, http://www.wsj.com/
6. "A Random Walk Down Wall Street: The time-tested strategy for successful investing," by Burton Malkiel.

1 comment:

  1. I think that this fear results from the fact that the elderly are living in a completely different world. It's true that they have witnessed the development of the internet over years. But, they have never been so dependent on it like the youths today.

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