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October 31, 2007 at 08:00 PM
Time after time, the stock market has proven that investors who stayed the course throughout good times and bad have been rewarded with decent returns, while those who tried to outguess the market have been punished. Computer investment models almost universally tell you that the best investment approach is take a long-term focus and ignore short-term swings. Good advice. The problem is the computer is asking people to make rational decisions, but most people make normal decisions, which means our emotions affect our judgment.
The road to financial success – quit reading
I have read that an investor using the Internet can access almost 300 billion pieces of financial information. The problem is having all this data does not result in wiser decisions, but instead leads to overconfidence, inaccuracy and confusion. Indeed, studies have shown that decisions get worse as our brains reach information overload, and this is a problem for investors and the professionals that advise them. This excess information goes to work on our greed and fear impulses and causes us to overreact. This overreaction means we buy high and sell low.
Fighting fear and greed with index annuities
An index annuity takes the consumer largely off the emotional roller coaster because it removes the dips in the track. The worst you can do is earn no new index-linked interest, but you get to keep the money you already have. This works to minimize the “sell low” fear signals we get during every market crisis. However, the siren song of potential investments gains calls to our greed side.
One of the rips used against index annuities is that you don’t get all of the upside. An index annuity interest rate does not take into account reinvested dividends, and you rarely get full participation in the index. Indeed, the effective participation rate of the better index annuities is often 45 percent to 55 percent. However, when you take away the dips, and turn stock market losses into a worse case of not losing what you have, you don’t need as much participation in the good years to get a competitive return.
