What is Stopping Me From Investing my Money??

Investing Anxiety

My friend Ann said, “What I want to know is: What is stopping me from investing my money?”

Ann is not alone. A Nationwide Financial survey found that more people are afraid of investing in the stock market (62%), than are afraid of death (58%), or public speaking (57%.)

Daniel Kahneman, psychologist and winner of the Nobel Prize in Economics, gave advice on this topic in his book Thinking, Fast and Slow. Kahneman gave this sermon to fictional character Sam:

“I sympathize with your aversion to losing any gamble, but it is costing you a lot of money.”

Kahneman advised, “You will do yourself a large financial favor if you are able to see each of these gambles as part of a bundle of small gambles and rehearse the mantra that will get you significantly closer to economic rationality: you win a few, you lose a few. The main purpose of the mantra is to control your emotional response when you do lose.”

The author did not condone reckless gambling. He had three limits on his “win a few, lose a few mantra.”

• Diversify. The gambles have to be independent of each other. “…it does not apply to multiple investments in the same industry, which would all go bad together.”
• Don’t bet the farm.  The gamble should be small enough so you are not worried about a significant loss to your wealth. “If you would take the loss as significant bad news about your economic future, watch it!”
• No long shots.  This mantra doesn’t apply to long shots which he described as “the probability of winning is very small for each bet.”

Kahneman said you have to have emotional discipline to follow the above rules. But his main point is that you should see each decision as one of many small decisions in a portfolio.  Emotional distress can also be reduced by cutting back on how often you check how your investments are doing.

Related Blog Posts

“How to Handle Emotions When Making Investment Decisions”

“When to Trust Your Intuition or Gut Instinct When Making Financial Decisions”

“How the Heck Do I Invest my Money?”

Sources

“Nationwide Financial Survey Finds Fear of the Markets Trumps Fear of Death”

“Thinking, Fast and Slow” by Daniel Kahneman, pages 338-339

When to Trust Your Intuition or Gut Instinct When Making Financial Decisions

Feelings and Investment Decisions (Click to Enlarge)

Traditionally, being rational and objective was highly prized in the investment decision process. Emotions were to be controlled and repressed for fear of making bad decisions. However, early studies that combine psychology, the biology of the brain, and investment risk are beginning to challenge that view.

I recently read an article in CFA Institute’s magazine called “Sentimental Journey” that reviewed recent research. Cynthia Harrington referred to research conducted by Columbia Business School professor Michel Pham and associates published in the Journal of Consumer Research. They researched how people’s trust in their own feelings affected decision-making. The exhibit below gives a quick summary of the research.

Why It Is Important to Know How Trust in Feelings Affects Decisions

The researches are trying to figure out if gut instincts improve the accuracy of predictions in decisions in uncertain events with high stakes. This could help decisions made by professionals in many varied areas such as the Pentagon, Wall Street, weather prediction, to name a few.

Methods

Summary of “The Emotional Oracle Effect” (Click to Enlarge)

People were divided into two groups:

• People who had high trust in their feelings
• People who had low trust in their feelings

Subjects were asked to make decisions in the eight studies mentioned in the Exhibit to the right. (Click to Enlarge.)

Conclusions on Whether Feelings Help us Make Better Decisions

People who had high trust in their feelings were more accurate in their predictions in all the studies.

However, this effect only occurs when people have sufficient background knowledge in the decision area.

People who trusted their feelings didn’t make rash decisions. They still took the time to carefully consider the information.

Why Feelings Can Help Us Make Better Decisions

While a more analytical approach with just a few inputs might seem more logical, it could be leaving out key information that your feelings are hinting at. Study authors speculate that when a person trusts their feelings about a subject they have experience with, they access “a vast amount of information that people learn consciously and unconsciously about their environment.” Professor Pham believes that feelings “…tap into all we know about our environment.”

Knowing how and when to trust our feelings when we are choosing an investment can help us improve our choices.

Sources

“Sentimental Journey” by Cynthia Harrington. CFA Magazine, March/April 2013.

“Feeling the Future: The Emotional Oracle Effect” by Michel Tuan Pham, Leonard Lee, Andrew T. Stephen

Related Posts

“How To Handle Emotions When Making Investment Decisions”

Review of PBS Frontline’s “The Retirement Gamble”

I recommend that you watch the eye-opening PBS Frontline Special “The Retirement Gamble.” Thank you to Claire for suggesting it.

Some key points from the program:

• Many hidden layers of fees are eroding individual investor wealth.

Jack Bogle, founder of The Vanguard Group, gave an example of how much fees cost an individual over a 50-year investing lifetime. If this consumer receives a 7% annual return and pays 2% in annual fees, fees will erode two-thirds of the investor’s gains. Bogle said you can see these results on a compound interest table.

I decided to do just that and found an investment calculator at Buyupside.com. (Please click on the image below.)  Using the same figures show that the portfolio would be reduced by 63.58%. We should all be checking the fees on our retirement plans!

Investment Key Calculator (Click to Enlarge) http://www.buyupside.com

• Robert Hiltonsmith, a policy analyst at Devos, examined his own retirement plan to see what fees were taken out of his account. He found that about 25 fees were extracted from his account by mutual funds, fund brokers, plan adminstrators, etc.

• Teresa Ghilarducci, economist at The New School for Social Research said:

401(k) plans were originally designed for wealthy people. Now, the advisors middle class have access to are really just sales people.

American consumers don’t know the price, quality, or dangers of their 401k plans due to strong industry lobbying.

“So we know after 30 years of this 401(k) experiment that people do worse in 401(k)s than they would have if their money was in a traditional plan or if it was in a plain vanilla retirement account.”

• Many of the options in plans are mediocre and many people are not prepared to invest their own money.

This became clear to me when I had someone from a cable company come to my home to repair the phone. When he saw that I had the TV set to a financial news channel, he began telling me that he had all of his retirement money in marijuana stocks. Although his portfolio had lost 50% of its value at this point, he was very optimistic about his future prospects. I was very shaken when he left as I wondered how many people were investing their retirement funds this recklessly.

• According to the Department of Labor, there are no clear standards on who can give advice to consumers of retirement plans. Also, there is no clear way for a consumer to tell who has the expertise to advise them. There was intense industry lobbying when new standards were proposed, forcing them to be withdrawn.

Source:

PBS Frontline. Videos and transcripts.

Related Posts on This Blog

“Resources to Help You Decide  When to Take Social Security”

“A Critical Step for Preparing for Retirement”

“How the Heck Do I Invest My Money?”

“Book Review -‘The Bankers’ New Clothes: What’s Wrong With Banking and What to do About It”

Why are interest rates so _______ ______ low?

This post will pass along some interesting snippets of conversation about interest rates from a financial conference I attended on Friday. This article will close with a few easy-to-use, educational resources on fixed-income investing for you.

There was a fascinating discussion on the fixed-income markets* at the Archway Investment Fund Forum at Bryant University.

HERE ARE SOME OF THE VIEWPOINTS:

The Federal Reserve Influences Interest Rates

Interest rates are projected to stay low until 2015. That’s good for borrowers but bad for others such as individual savers, pension funds, etc.

Causes of Low Rates

The Federal Reserve intervenes in fixed income markets in two ways:

1. The overnight rate is kept near zero.
2. By purchasing long-term Treasury bonds and mortgage-backed securities, the Fed lowers the ten and thirty-year rates.

There are other reasons for record low rates:

Regulators Force Banks to Cut Leverage

• There is massive deleveraging (paying down debt) throughout the economy. This is a legacy of the credit bubble.

• Regulators are forcing banks to delever.

• Each generation in the U.S. goes through a financial crisis and is forced to delever. Similarly, each generation in Europe, in its own cycle, has a crisis and is forced to delever. However, every 1.5 generations, both the U.S. and Europe go through a crisis that leads to deleveraging at the same time. We are going through one of these periods now and that’s why the recession is so severe.

• 

  Investors Buy Treasuries When They Panic

  Panic. Treasuries are seen as the safest investment around the globe. Whenever there is bad news, everyone rushes to buy Treasuries, driving down interest rates. Ironically, even when a ratings agency downgraded the U.S. Federal government, investors panicked and bought Treasuries.

Other Opinions on the World Economy

Italy, Spain, and France need to make painful cuts. Japan and Europe are losing population. One participant was optimistic about the U.S. because the country has population growth, productivity, and labor mobility.

When will rates go up?

• When economic growth is greater than expected

• Inflation is expected in the next two to three years

RESOURCES FOR FIXED INCOME INFORMATION

• “Investors’ 10 most common mistakes” by Barry Ritholtz, Washington Post.    I liked this quote from the article,  ‘Reaching for yield: there are few mistakes more costly than ‘chasing yield’…”                  “There are three common ways to chase yield: 1.) by buying longer-dated bonds: 2) by buying junkier, riskier paper; or 3) by    using leverage, which amplifies your gains but also amplifies your losses.”

• Two slide shows from Investopedia:  “Top 6 Uses of Bonds” Slideshow. “8 Ways to Lose Money in Bonds” Slideshow

•  Morningstar’s Investing Classroom. There is a curriculum in the form of a slideshow for bonds.

*Fixed Income and Alternative Investments Panel: Erica Vaters, Fidelity; Howard Jones, BlackRock; Joseph Fazziono, United Technologies; and Tom Tzitzouris, Strategas Research Partners.