Investing is like a game of chicken:.Folks who are fearless tend to come out on top. The recipe for success - at least the one that has historically panned out - is deceptively simple: buy and hold stocks for long periods of time, and continue to do so when markets look ready to crumble. Buy more, in fact, when markets are crumbling. Which is why the fearless win. While that is doubtless a sensible formula - gobbling up cheap assets and selling when they are expensive is not a hard profit-making concept to grasp - in practice it takes a lot more guts than many of us have. Unfortunately, we are human (unless you are Warren Buffett). And being human means we tend to follow the crowd in good times and bad, bidding up assets in bull markets and pushing down prices in bear markets as fear sets in.
There is plenty of evidence to suggest that fear is now at a historic high. And following the bankruptcy of the US investment bank Lehman Brothers, the forced merger of the brokerage giant Merrill Lynch and the bailout of American International Group, the world's largest insurer, who could be blamed for feeling fearful? The MarketPsych Fear Index, which mines research and news reports for trepidatious phrases, reached a two-year peak last week. The Investor Confidence Index, a measure developed by State Street Global Advisors in Boston, has been on a downward trend in the past couple of months.
So fear is high, confidence is low and stock prices are tending downwards. If you have your own case of jitters about the markets, you are far from alone. History tells us you should go against the grain and buy stocks. But how do you get past that fear? "If you are thinking of selling because you are afraid, wait several days before acting, since the price will usually be better then," says Richard Peterson, an expert on market psychology whose firm publishes the aforementioned MarketPsych Index. "As a trader, it is best to buy on decreasing fear. And if you know in advance what events are likely to decrease fear, such as the passage of the US bailout, then it is good to buy on fear there."
Other techniques Mr Peterson recommends for getting over your market heebie-jeebies: making yourself well aware of the fear around you so you know you are not the only one getting the shakes; "reframing" your fear by thinking about low prices as an opportunity; planning for the long term; and avoiding panic. But where, exactly, does this fear come from? The burgeoning field of behavioural finance has begun to untangle the complex psychology of investing in recent years, and has found that often we hold back on investing during uncertain times, not because we fear a further decline in the markets but because we fear the feeling of regret that could be caused by such a decline. Those are two different things: we are not risk-averse, we are regret-averse.
As Meir Statman, a professor in California who pioneered research into the role of regret, put it: "investors try to avoid the pain of regret by avoiding the realisation of losses, employing investment advisors as scapegoats and avoiding stocks of companies with low reputations." Although the US president Franklin Delano Roosevelt boomed back in 1933 that "the only thing we have to fear is fear itself", for investors it seems that regret is the number one bugbear.
And the number one way to stymie regret is to remove emotion from the equation in the first place by automating your plans and making them very difficult to sabotage. It is the investing equivalent of putting a strong lock on your freezer and leaving the key with your sister. The next time you get a craving for caramel crunch ice cream, you will probably be more likely to just skip it than to go to your sister for the key.
There are numerous ways to do this in practice. If you have a relationship with a broker or a financial advisor, it is easy. Arrange with them to set up automatic contributions from your current or savings account. Then tell them that in order to make changes in your monthly allotments, you have to call them and give 30 days' notice. This tool works in two ways. First, it is slightly embarrassing to call up your advisor and say you want to veer from the investing plan you both agreed upon when you set it up. And second, it forces you to give notice so the changes do not take effect immediately, which means that it will be harder to press the panic button in a market scare.
"One client just called up and said he wanted to reduce his payments to the minimum possible," said Jonathan Brookes, a financial planner in Dubai. "What was he going to do when the markets go back up again? He said he'd increase it. Once you talk about it out loud and talk about what your plan is and what's happening, it becomes easier to stay put." Which is why having a trusted advisor during times of trouble is another key to avoiding trying to time the market and withdraw all your money when things get tricky. A good financial planner, if he is good, can help you buck the prevailing fear and stick to your guns when the going gets tough.
"We're trying to reassure clients that we are here for them," said Kurram Jafree, the head of investment management at Barclays Wealth in the Middle East. "In this environment we are facing, you should continue to invest in absolute return strategies and in market-based strategies. There are going to be opportunities." If all that isn't enough to keep you in the game, take a quick glance at history. Markets have tended upwards in the long run - the stocks of large American companies have averaged returns above eight per cent per year since the 1930s - and people who got out when they went down ended up earning less.
Two years ago, the mutual fund tracker Morningstar began publishing "investor returns", or the returns actual investors made, taking into account their timing. It painted a depressing picture, showing that the published total returns of many funds was far higher than what people actually made because they took their money out and put it back in at inopportune times. American Funds Growth Fund of America, for example, the largest mutual fund in the US with nearly US$180 billion (Dh661.23bn) in assets, has returned 10.77 per cent per year in the past 10 years. Largely because of bad timing, investors in the fund made only 7.97 per cent per year. Ouch.
afitch@thenational.ae
