Mired in Despair

A Glimmer of Hope

When I talk with prospective clients about their financial future, I find that their feelings range from apprehensive to despair. Few seem at all hopeful or optimistic. This is natural amidst the deadlock and acrimony in Washington and in the aftermath of a devastating recession and fitful recovery. And yet we know from history that we are likely to see better times in the future. It has been a modern conceit that we could override human nature and suppress the business cycle. What we have shown is that with great technology and modern communications, we can accelerate the business cycle and perhaps make the downturns worse, not banish them. Still, just as we’ve experienced a historic bust, we’re likely to have a historic boom again at some point. It pays to be realistic but not get mired in despair. Those who are too gloomy may make bad mistakes and get disappointed yet again – when once again good times roll. And failure to plan for prosperity can be almost as big a mistake as assuming that hard times will never come. Successful investing requires balancing prudent risks and that means balancing emotions too.

Illusion of Control

Bad Behavior

“We have met the enemy and he is us.” That’s the famous quote from Walt Kelly, cartoonist who drew the Pogo series. It applies especially to investors. A study by the financial consulting firm Dalbar showed that for the 20 years ending December, 2010, investors achieved less than half of the return for the mutual funds they participated in: 3.83 percent a year for investors versus 9.14 percent for the funds. Why is this? In large part because investors let emotions dictate their actions rather than put thought into what they are doing. They let fear and greed dictate buys and sells. Recently we sponsored a talk on a behavioral approach to investing. The speaker, Jay Totten of Dimensional Funds, used recent research to show the inherent problems investors have and how to counteract them. The problems he cited included overconfidence, illusion of control and aversion to loss. He suggested that one way to minimize these problems is to stick to a plan. He recommends focusing on good decisions, not outcomes, and controlling what an investor can control such as diversification. That makes it easier to accept what happens, which is partly a matter of chance.