Sunday, July 27, 2008

How to Control Your Fears In a Fearsome Market

WallStreet Journal
How to Control Your Fears In a Fearsome Market
Saturday July 19, 1:05 am ET
By Jason Zweig

What goes on inside your head when your portfolio implodes?

One of the fear centers in your brain, the amygdala, can respond to upsetting stimuli in 12 milliseconds, or one-25th the time it takes to blink your eye. These brain cells fire when an attack dog snarls at you, a spider drops down your shirt or the Dow Jones Industrial Average takes a dive.

Merely reading the words "market crash" in this sentence can instantaneously jack up your pulse and your blood pressure, the output of your sweat glands and the tension in your muscles. Stress hormones will flood your bloodstream. Your eyes will widen and your nostrils flare, making you hypersensitive to any further danger. All this occurs automatically, involuntarily and unconsciously. You can't be an intelligent investor if, without even knowing it, you are thinking with the panic button in your brain.

The countless people who bailed out of the market in the horrifying plunge of October 2002 missed out on the generous returns of 2003 through 2007, when stocks returned 12.8% annually. The same is likely to be true of those who cut and run in today's turbulent market.

Fortunately, you can train your brain to stay calm when the markets are gripped by panic. Last week, I spent an afternoon in Kevin Ochsner's neuroscience lab at Columbia University in New York, practicing what he calls "cognitive reappraisal."

I sat at a computer and viewed a series of photographs, each preceded by one of two words: look or reappraise. look was my cue to respond naturally without trying to change my feelings. reappraise told me I should "actively reinterpret" the photo, using my imagination to spin another, less emotional scenario that could have resulted in the same image.

Dr. Ochsner had warned me to eat an early, light lunch, and I immediately realized why: I gasped at the sight of a man's hand from which most of the fingers had been freshly hacked off. But my instruction had been to reappraise, so I forced myself to ask whether this image might actually be a still from a horror movie. Magically, the moment I imagined it was a film prop, the raw flesh seemed to look a bit like plastic, and I felt myself exhale.

If I can think away blood, you can calmly face the red arrows on a market Web site. "Emotions are malleable," Dr. Ochsner said, "but people often don't realize how much [of what you feel] is under your own control."

Here are some ways you can control your fears.

Reappraise. Forget what you paid for that stock or fund; instead, imagine it was a gift. Now that it is priced, say, 20% more cheaply than in December, should you want to return the gift? Or should you buy more while it is on sale? (If rethinking a fallen price this way doesn't make you feel better, maybe you should sell.)

Step outside yourself. Imagine that someone else has suffered these losses. Think of questions you might ask to give that person advice: Other than the price, what else has changed? Is your original rationale for this investment still valid?

Control your cues. Even witnessing someone else's pain, or glancing into another person's frightened eyes, can fire up your amygdala. Because fear is as contagious as the flu, quarantine yourself from anyone who obsesses over the momentary twitching of the Dow. Tear yourself away from the computer or television; better yet, while the market is closed, make an advance date with friends or family to get your mind off stocks during market hours.

Track your feelings. Fill in the blanks in this sentence: "Today the Dow closed down [or up] ___ points, and that made me feel __________." Your emotions shouldn't be hostage to the actions of the roughly 100 million other people who compose the collective beast that Benjamin Graham called "Mr. Market." You need not be miserable just because Mr. Market is.

Finally, if the market is open, your portfolio should be closed. Sleep on any sell decision until the next day, when your fears may have faded. Intelligent investors act out of patience and courage, not panic.


casual observer said...

"The countless people who bailed out of the market in the horrifying plunge of October 2002 missed out on the generous returns of 2003 through 2007"

That is true, but if those same people bailed out at the first sign of trouble back in 2000, they would have missed the entire downturn from 2000 - 2002. You're forgetting about the old saying, "He who panics first, panics best." In a game of musical chairs (our highly leveraged speculative markets), sometimes its best to act first and act fast.

Paul said...

This post is making me scared!!!

Deliverator said...

The stock market correction in the US has a lot further to go, last week's 'rally' was more of a dead cat bounce.

Wall Street is looking for Main Street to provide them with their exits. Expect to see a lot more 'buy now when it's cheap' articles in the coming months-years.

jesse said...

The concept of sunk cost. Good tips, even for seasoned investors.

Cynixinc said...

Cost averaging is the way to go - keep investing money into the appropriate type of investments to maintain your target investment mix on a regular schedule. Ignore the market ups and downs - it's just noise that only impacts speculators or investors too heavily invested in stocks vs. bonds or cash.

deedavid said...

I have 23K invested in 2nd mortgages, representing 5% of our total investments.

with the market looking like it is going soft, I'm ready to pull the plug. you could say panic is setting in.

how did RE developers do in past down turns, did the 2nd mortgage holders get caught holding the bag.

Metaldwarf said...

does anyone have any thoughts on how Real Estate Income Trusts (REIT) might perform over the next few years, they have done very well recently.

The primary idea is that the trusts buy buildings and rent them out. The rental income pays out through the funds similar to a dividend. They don't sell buildings often/ever so even if there is a huge crash they likly won't have any capital losses since they won't sell the buildings. As prices fall rents might as well so that could have an effect.

Anyone have any insight?

i have money in the Great West Life Real Estate Fund
and the IAP Real Estate Fund

mohican said...

deedavid - I personally wouldn't want to hold any undiversified' debt instruments and especially not 2nd mortgages on development properties.

Just my 2 cents.

metaldwarf - REITS are certainly less risky than owning individual rental properties. When looking at at a REIT as an investment be sure to keep an eye on the debt levels. When using a REIT etf or fund, keep an eye on the fees.