Psychology and Investing

Psychology and Investing

 

Illustration of the crisis concept with a businessman in panic

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In the past sixteen years, US investors have experienced two of the worst or most difficult financial market First an investor should decide between two basic viewpoints about markets. During the 1960’s, Dr. Eugene Fama developed the Efficient Market Hypothesis (EMH) as his doctoral dissertation. For his work in this area, Dr. Fama was recognized with the Nobel Prize for Economic Sciences in 2013

EMH proposes that at any particular point in time, investment players all know and have access to relevant information so that a stock, bond, or market’s current value must be accurate. If this is true, it is impossible for any investors to outperform the market other than by sheer luck. The investment decision becomes simple—buy and hold low cost exchange traded funds containing broad indexes of all investments. Examples include the Russell 3000, the Nasdaq 100, and Barclay’s Aggregate Bond.

Morningstar data reveal that choosing the right indexes would have been critically important in the past ten years through June 30. The Nasdaq 100 had a total return of 178 percent while the S&P 500 gained 104. The bond index generated a total return of 61 percent for the decade.

However, the financial literature is filled with the unfortunate truth that no one ever has a Rip Van Winkle experience in which he leaves everything alone, awakening 10 or 20 years later with a huge market gain. Most people manage investments with their emotions—both fear and greed. This is the stuff of Behavioral Finance. Technical Analysis of financial markets is based upon this consistent human nature. It observes natural rhythms of human psychological nature and its collective effect upon the value of all investments tradable in generally open and free markets.

If you are lucky enough to live long and prosper, in Dr. Spock’s words, then EMH investing may work for you. But don’t die during a bear market like late 2008 or early 2009. That can really mess up your financial plan.

Since we do not have longevity crystal balls, I prefer the second approach built upon Behavioral Finance and Technical Analysis. It focuses upon minimizing loss wherever possible and taking advantage of those changing tides of valuation. Instead of owning everything all the time, I believe one can overcome enough of his own greed and fear with discipline in the investing process.

As an example, we still have ridiculously low interest rates paying less than core inflation. This aids borrowers (major corporations and billionaires) and punishes savers. Savers are looking under every rock imaginable for some interest yield with safety. This is why bonds are so relatively expensive in price and currently yield so little. Few investors alive actually remember that bonds were in a bear market from 1946 until 1981 when 30 year Treasuries hit 15 percent yield in October of that year. (http://www.tradingeconomics.com/united-states/30-year-bond-yield).

At some point, the tide will reverse and bonds will drop in value since new issues will be yielding higher interest. Those who invested in stocks when so many are still so fearful will be rewarded.

(Past performance is no guarantee of future results. Advice is intended to be general in nature.)

July 27th, 2016|Categories: Economy, Investment Management|