Even the pros gave in to panic
THE SAVAGE TRUTH | Times like these are scary, but let long-term planning, not emotions, rule
Gotcha! That's what the market said to all those investors who panicked and sold out of fear on the way down last week. And guess what? The ones who panicked most were the professionals!
They're supposed to know better. After all, they're paid to manage money in the markets. Yet, it was the pros who executed those huge block trades just to get the financial companies off their books before the third-quarter reports go out.
(AP)
And it was the pros who pulled millions, and even billions, out of money-market funds because they worried not only about Lehman paper, but about the entire corporate borrowing market.
It was the professionals around the globe who panicked and piled into Treasury bills -- pushing yields to nearly zero, just as the Treasury was creating billions of dollars in bailout credit that is certain to swamp the value of the dollar (unless, of course, it disappears down the black hole of defaulted swaps and write-offs).
Ordinary investors became the -- relatively -- smart money. Perhaps it was fear that paralyzed many people and kept them from selling instantly. Or maybe it was because they use mutual funds and knew that the daily prices are set after the close -- causing them to pause and pray for a rebound.
This is not an argument that buy-and-hold always works. The impact of the financial crisis will certainly take its toll on the broader economy. And there is a good chance that stocks will move lower to reflect that.
But it is an argument that smart investors resist those two emotions so closely tied to human nature: fear and greed. Greed got us to this point. Fear destroyed billions in assets instantaneously.
On a more sophisticated level, experts in the field tell us that resisting the siren call of emotion is not just about self-discipline. The science of "radical neuro-economics" explains how feelings and actions are related.
Denise Shull is president of TraderPsyches, a New York consulting firm specializing in teaching better methods for human decision-making in the financial markets (www.TraderPsyches.com). She and her staff of three modern psychoanalysts work with traders to teach them how to use their emotions to their advantage.
How did those teachings work last week?
Says Shull: "It's a myth that you can control your emotions. Neurologically, you can't. But what you can control is your actions -- if you understand what's really driving your emotions."
Shull explains: "The emotional networks in the brain 'fire' long before the analytical networks in the brain. Feelings are information and motivation. But they don't have to automatically result in action. The trick is to view those emotions as information, allow yourself to understand and identify your feelings, and only then make a fully informed decision."
This process involves more than trading discipline, she explains.
"The markets plug right in to people's deepest insecurities at the core level and cause you to feel emotions that are way out of proportion to what's happening. When you try to control those emotions or deny them, inevitably that energy will push you into taking an action that, in retrospect, will always be irrational -- and expensive!"
And, says Shull, that's as true on the most sophisticated trading desk as it is for the individual investor.
So how did you deal with the emotions of this past volatile week in the financial markets? What did you do -- or not do -- that you now regret? What will you do differently the next time around? These are not idle questions because this is certainly not the last market crisis you will face.
For the ordinary investor, the best strategy, according to legendary market gurus like Vanguard's Jack Bogle and economist Burton Malkiel, is to just "go along" with the market in an index fund. Malkiel, author of the legendary book A Random Walk Down Wall Street, explains that only a minority of managed equity funds have managed to beat their benchmark indices.
As we all know, over the "long run," the market has historically beat the returns of T-bills and CDs. So exposure to stocks is necessary to build a retirement portfolio. The only real issue should be decided in advance: asset allocation -- how much in stocks, or bonds, or safe cash equivalents. That's a decision best made in a calm moment, not in the midst of turmoil.
But what happens when ordinary investors -- and even professional traders -- are suddenly confronted with volatile markets like the ones we saw last week? Long-term planning and asset allocation and determined self-discipline go out the window. Emotion rules. Then they're sorry. And that's the Savage Truth.
For more on the crisis, visit my blog: blogs.suntimes.com/savage.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate. Copyright Terry Savage Productions Ltd.