Sunday, May 24, 2009

Don't Be Happy! Worry!

Lately, Americans seem to have breathed a collective sigh of relief. With the stock market rising like the mythical phoenix people are beginning to feel that the storm has passed and that the future is again full of promise.

Not so fast, says Jason Zweig in his latest Wall Street Journal column. Link here.

Following in the footsteps of legendary value investor and Warren Buffett guru Benjamin Graham, Zweig offers some lessons in how not to get caught up in crowd enthusiasm.

As he puts it: "...today the market seems to be in just the kind of mood that would have worried Mr. Graham: a jittery optimism, an insecure and almost desperate need to believe that the worst is over."

If you want to be a better investor, Zweig advises you not to trust your emotions. Turn them inside/out. Be "inversely emotional."

Whenever you find yourself swept up in a wave of collective enthusiasm, don't enjoy it. Start worrying.

When everyone is thinking the same thoughts and feeling the same feelings, the odds are excellent that everyone is wrong.

The psychology is easy to understand. If you held on to your stocks through the dark days of fall and winter, the current rally feels like vindication. You are not as dumb as you thought; you are really smarter than all of those fools who sold at the bottom. You are a long term investor; you can tough it out through a few market gyrations.

It feels as though the market has come to the rescue of your battered self-esteem.

To repeat a point that I am still not tired of making, markets are not in the business of bucking up your self-esteem and redeeming your mistakes.

But what kind of person can turn his emotions inside/out. What kind of person can be detached from his feelings, especially at a time when major cultural institutions are telling him to get in touch with said feelings.

Turning your emotions inside/out requires what Graham called "firmness of character." To do this effectively you need to feel detached from your own feelings. You need to adopt a more philosophical attitude and a healthy skepticism toward emotional contagion. Above all you need to think of investing as a job.

At a time when the old investment strategy of buy-and-hold has fallen seriously out of favor, Graham would advise a strategy of dollar-cost-averaging.

This means investing the same dollar amount in, for example, a mutual fund, every month... no matter what. When the price is higher, you will be buying fewer shares. When the price is lower, you will be buying more shares.

Obviously, this is not as easy as it sounds. It requires severe discipline and strength of character. After all, when the market is zooming ahead we want to invest more; when it is falling apart we want to invest less.

One reason is that we like to feel like we belong to the crowd, and we imagine that feeling what everyone else is feeling makes us members in good standing of the group.

This is an illusion, but why quibble.

The other reason is that when our investments go up, we feel like mavens, as though we cannot go wrong. But a falling market makes us feel like fools, as though we cannot get anything right.

Going with your feelings, getting carried away on a wave of collective glee is like going to a party.

Investing, however, is not a party. Investing is work. If you act like it's a party, the joke will eventually be on you.



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