“The market is like a beautiful woman – always fascinating, always mystifying.”

– Edward Johnson III

We concur with this statement. The investment arena is a great area for analysis by psychologists. Time and time again, people let their emotions dictate their investment decisions. Our experience shows us that this leads to poor investment decisions that can have a significant negative impact on their financial future. Emotional decisions can be borne out of either the euphoric rush that occurs when markets are rising -gold in the late 70’s, technology stocks in the late 90’s and real estate and oil markets today – or the panic/fear that occurs when the market is falling – bear markets of ’73-’74 and ’00-02. Many people have been lured by the beautiful woman only to find out she is a black widow ready to strike at their fortune.

The Euphoric Rush

Psychological studies have proven that investors get addicted to the euphoria of rising markets just like addicts do. The brain releases a chemical called dopamine that makes investors feel good when they make correct predictions under conditions of risk and uncertainty. This is the same chemical release for an addict that is “high” on drugs, gambling or sex. In addicts, the brain actually releases the dopamine prior to the addict engaging in the action that gets them “high”. In other words, the dopamine gets the addict high prior to them getting high from their addiction.

As a pattern of correctly predicting investment gains develops, the addict becomes ever more addicted to the investment. All logic is thrown out the window as the addict enjoys the high. At THOR, we lost clients because of this euphoria during the first quarter of 2000. These clients had invested money outside of THOR in technology stocks that had significantly grown in value over the past few years. When we told them that we believed the technology bubble was about to burst and that they should get out of technology stocks, we saw first hand how euphoria overrules logic. We heard comments like: “technology is the wave of the future”, “technology stocks should be valued differently than other stocks”, and, our favorite, “you guys at THOR are idiots”. Because of our recommendations, these clients terminated their relationship with us and went on to invest their money in technology stocks. As we all now know, that move was a mistake and dampened, if not ruined, their financial well-being.

Panic/Fear

The dark side of the “beautiful woman” is panic and fear. This panic and fear is compounded if one gets addicted to predicting investment gains during a bubble market. When the predictable pattern is broken, the addict’s brain triggers a visceral response. Not only do they experience fear and panic, but depression sets in as well. We saw that depression in technology investors during 2001-2002 as technology stocks plummeted. One of the problems with addicts is they tend to transfer their addiction to another beautiful woman. They seek a rush somewhere else – perhaps the real estate and oil markets of today.

Panic and fear is probably the single biggest reason for loss of wealth in the stock market. The panic selling of stocks during periods of negative market turbulence – October 1987, September 11, 2001, and July 2002 – can be devastating to one’s financial future. Even though our clients made money in 2000 and 2001, when the market capitulated in July of 2002, we had several clients who wanted to sell off a portion or all of their equity positions. Fortunately, we provided a buffer that prevented them from making such a devastating emotional decision. For most, if not all of these clients, it took less than 9 months to fully recover the portfolio losses and reach new highs in their accounts. If they had sold off after the market capitulation and reinvested the proceeds in bonds or cash, it would have taken over 6 years to recoup those losses!!

Solution

So how do you fight emotional decision making in the market? First, realize that investing is not a game. You should not jeopardize your future on the “euphoric rush” of playing investments as if it were a game. There certainly are some people that can manage their own investments and not get caught up in their emotions. However, most can not. Even professional money managers can get caught up in their emotions. But most professional money managers have a structured investment process in place that is designed to filter out emotional investing.

We at THOR have insulated ourselves from making emotional decisions in two major ways. First, we have a very disciplined investment model. Our model is our guidepost to investing. Although our emotions may tell us to continue with a style because it has performed very well over a period of time – small company value stocks over the past 5 years – the model directs us to styles that will outperform in the near future. Second, we realize we are human and have emotional tendencies as well. That is why all of our investment decisions are made by our investment committee using a team approach. The three partners at THOR are equal owners and thus have equal standing on the investment committee. If one member has an emotional tendency, the other members counter that tendency with facts, our investment model and reality.

Firm Update

• THOR has been recognized by Bloomberg Wealth Manager as one of the top 500 financial advisory firms in the country.
• Congratulations to Jim for completing the Chartered Alternative Investment Analyst (CAIA) program and becoming a CAIA designee. Jim serves as the Chief Investment Officer of THOR and is also a Chartered Financial Analyst (CFA). Recognized globally, the CAIA designation certifies one’s mastery of the concepts, tools and practices essential for understanding alternative investments and demonstrates one’s commitment to the highest ethical and professional standards. Jim’s interest in this program was sparked by THOR’s investment in a commodity fund in the fall of 2003.
• We just held our annual client appreciation dinner, a small token of our appreciation to our clients. Ralph Wanger, founder of the Acorn group of funds, was the keynote speaker. A good time was had by all and we hope all of you can attend next year.