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February 12, 2004 at 07:00 PM
Emotional Investing: Do Leave Home Without It
By
A producer recently told me the following tale about one of his clients who has flipped and flopped between the market and index annuities.
A little less than a year ago, during the period when the market had backed off some recent gains, this client came into the office and announced he was done with the stock market.
The client said he had moved into mutual funds in 1999 because of the tremendous growth of previous years, but now, after watching his funds dwindle, he had sold them all–because he realized “you always lose in the stock market.” He said he wanted to buy the index annuity that the agent had been suggesting. And so he did.
Then, last September, after the stock market had risen significantly, the client returned to the producers office demanding that the index annuity purchased 6 months prior be surrendered. The client said he had determined he could make more money in the stock market.
When the producer asked the client why he didnt think he would make the same mistakes this next time around, the client responded: “Because Im much smarter now.”
For financial professionals, this tale has several lessons. As in celebrity Garrison Keillors Lake Wobegon, where all the children are above average, we seldom admit the possibility that some of us are below average drivers, poker players or investors. When we do succeed we are more likely to credit our skill and prowess, rather than luck and circumstance.
To make things worse, we use our emotional compass as an investment strategy.
In 2000 and 2001, for example, consumers were in hope mode, whereby they did nothing when their investments fell a little on their way to falling a lot. Why? They hoped their investments would go back up.
Then, in 2002 and 2003, consumers entered fear mode. Many sold their investments, convinced that the bad times would continue forever.
