October 9, 2008--Dealing with emotional times

Greetings.

I try to have a clear sense of my role as your advisor, especially during turbulent times in the markets. Communicate, answer your questions and emphasize the rational perspective in the midst of emotional times. These are emotional times and are response is not helped by the newspaper or CNN, so it's important for me to provide perspective in the midst of the noise. I hope these newsletters help, and be assured that I will keep writing them.

I attended a four hour seminar yesterday that was well-timed. The subject was stock market history and, in particular, the general behaviour of investors, economists and the media during times of bad markets [called "bear" markets]. Let me share a few of the highlights.

Not surprisingly, falling portfolio values can make us feel fearful, triggered by the question "how bad can this get?" We know that economists are not immune to this fear and so their comments are not always helpful. Thus fear can turn into panic in which people become irrational and say "sell at any price, let's just get out." This behaviour, although self-destructive to our portfolios, occurs when emotions over-rule the mind.

Another quick example of the power of fear was documented during the SARS virus crisis in Asia: one in four people thought that they were likely to get the virus and die, even though the actual probability was many times smaller.* How can we deal with fear and avoid panic?

Focusing on the facts related to bear markets helps our mind to keep the fear in check. So let's do that. The facts about bear markets are--

-Bad markets have always been followed by good markets and that is why patience is critical to success.

-Trying to time the markets to avoid bear markets, however tempting the thought, is not practical.**

-Bear markets are what we have to tolerate in order to have growth in our money over the long term and achieve our goals.

-Our mutual fund managers are always active. With this, they have lessened our loss as compared to the broad market index and are now actively buying bargain stocks which will assist the recovery of our portfolio when good markets return.

-For those investors still in the saving time of life, it's important that they continue to invest since cheap stock prices in good companies are available now. A bear market is an opportunity.

-Most investors have consistently done the wrong thing at the wrong time by buying high and selling low. We must not follow the herd. Fight the good fight

When we try to stay rational, our emotions may fight back. And what is the number one lie that our emotions will scream at us--"it’s different this time!" That lie comes out with every bear market we humans go through. And we need to recognize that this lie fuels the newspapers and the CNNs, for the simple reason that they want you coming back to hear more. Their role is not to give you good advice. But it is my role.

If you want to read more, I’ve offered some thoughts below.

Warm regards,

Tom

*You can read more at-- http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_hassett&sid=aO8VJ9Y7qjrQ

**Why is timing the market so hard? Because we need the crystal ball twice: Once to know when to sell; once to know when to buy back.

My other thoughts if you want to read more-- I mentioned Warren Buffett in my last email, one of the wealthiest men at $50 billion. Did you know that seven months ago, Buffett was worth $62 billion? When markets go down, he's not immune to paper losses. Here's the question I have--if you and I lost $12 billion, how would we react? Would we be tempted to sell and run for the hills? What did Buffett do? He invested $8 billion of his money. Why? Because he saw opportunity in the bear market and did what he's done all his life: invest when others are afraid. He's sticking to the process that made him wealthy in the first place. Buffett is rare as seen by the wealth that he has accumulated.

When Buffett is asked what the "secret" of his success is, he answers that he was fortunate enough to study with the father of "value investing," Ben Graham. Among the ideas that Graham put forward is that the price of a stock today may have nothing to do with what the stock is worth. Remember that stocks trade by auction, so every time someone sells, it's because someone else is willing to buy.

Further, in bear markets—when sellers line up in a panic to sell—it follows that the buyer has the possibility, then, to buy stock very cheaply. If the buyer has done his homework and identified a fundamentally sound company, he needs then to just wait and buy when that company's stock is on sale at a good discount. No wonder then that Buffett [and the fund managers that I like to use] are busy buying during this bear market.

If this sounds simple enough, why doesn't everyone do it? Because a bear market is accompanied by fear and panic and these can paralyze rational behaviour. Buffett is rare because he remains rational even when surrounded by fear. There’s one more ingredient that goes into “being a Buffett.” Once you’ve bought stock in a fundamentally sound company at a good discount, making money requires patience while waiting for the stock price to go up. And you must continue to be patient even if the stock you’ve bought goes down in price [this requires fortitude].

Finally—and then I will stop for now—being a Buffett is not about being right all the time with your stock picks. That would be impossible. But the discipline of buying good companies when their stock is on sale is all about increasing your probability of making money. You don’t have to be right with every company in order to win in the long run. That’s what Buffett has shown and Ben Graham taught him.

Tom Buck, M. Ed., CFP
Certified Financial Planner
Assante Financial Management