Psychological barriers to investment – and why they are ignored

6th February 2012

"One of our busiest days ever was when the market bottomed on August 9th  last year at 4,791 – although it was typically sophisticated investors piling into the market and seeing it as a time to buy," says Darius McDermott from IFA Chelsea Financial Services. "But investors generally are a bit more resilient than they were, as we're in a 12-year bear market now, with the FTSE still at a low compared to its December 1999 peak – they are more relaxed and better informed these days with all the coverage and access to the internet for regular information."

Some level of resilience – that ineffable quality that allows some people to be knocked down by life and come back stronger than ever – has been cultivated among the investment community.

Anyway, as Mindful Money's psychologist blogger Kim Stephenson asks: "Why is 5,000 significant – why should it make any difference? – 5,000 is just a number".  So maybe people thought, "it doesn't really matter, but other people will think suddenly that shares are cheap and they'll buy in – now is the time to buy, before it bounces back again". 

He adds: "But people still believe these things, like they believe they can predict what is going to happen in a complex system although it is demonstrably impossible, like they take a huge interest in celebrity parties that they will never attend, like they are ecstatic or depressed over the fortunes of a small band of sportsmen or women whom they have never met, never will meet and with whom they probably have nothing whatsoever in common.  It's just people being people, we've all got huge sets of wiring in our brains that have a propensity to see linkages that don't exist – we have superstitions for that reason. "

Of course, many investors will have ploughed on through past turbulent periods and crises – and know the long-term trend is upwards. Those who've been through previous recessions have learnt that life goes on. People, and the market, adapt – and get used to economic downturns. Economic crises form part of history, and there is upside to be gained in recovery for those who hold their nerve.

However, financial editor Anthony Hilton says in the Evening Standard: "One of the interesting things about today is that so many people have not seen it all before. Going for 16 years from 1992 to 2008 without a downturn may have seemed like a good idea at the time but it has created a generation where, in effect, no one under 40 had seen bad times in their working life. The bust was all the more painful because they had no idea how to adjust."

But perhaps now the financial crisis has rumbled on for several years, investors of all kinds are adjusting – and keeping their focus on long-term gains, even when markets plunge below 5,000. Certainly the "Fear Index" – the Chicago Board Options Exchange Volatility Index (Vix), measuring how much investors will pay to protect against volatility on the S&P using options, implies confidence.

History shows that investors keeping their focus on long-term gain have the most chance of gains – and compared to the likes of cash and gilts, equities remain the attractive option at present, despite uncertainty. McDermott says: "The uncertainty is so great that investors can't make short-term calls – and equities are still proving to be cheap now."

Brian Dennehy from IFA Dennehy Weller & Co adds: "It is fair to say that the default state of mind is hopeful and optimistic. So as and when investors have cash available they will tend to invest, all things being equal. The obvious exceptions are short periods of extreme fear (so final quarter of 2008) when few bought, though opportunities were very real; or prolonged periods of heightened uncertainty. I believe the latter has been a drag for years, keeping investments volumes some way below their potential. I don't believe people invest despite bad news – everyone has different tipping points, and those who invest will have, rightly or wrongly, imagined a rosy future, and the bad news is simply not in focus for them."

But bad news often produces buying opportunities, when markets sink. For example, go back to 2009. Then, the FTSE 100 was as low as 3500, and a plethora of companies in the FTSE 350 were undervalued based on earnings and net asset value, showing all the characteristics of being wise investments – strong cash flow and potential for future growth. However, then many investors failed to take opportunities  – it remains to be seen what will happen this time round if the market sinks to that level.

Perhaps those who are keen to cultivate a sense of investment timing should remember this line from legendary investor John Templeton: "Invest at the point of maximum pessimism". He was one of the last century's most successful contrarian investors, scooping up shares during the Great Depression.


More from Mindful Money:

Facts are stubborn, but statistics are more pliable

Disentangling market messages – which indicators should we believe?

Distrust and its detrimental economic impact

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