Pressure Valve: Letting off Steam

Have you ever seen a steam pipe explode?

I did. I was in Boston driving down Boylston. I heard an explosion, checked the rear view mirror and what I saw looked amazingly close to the above photograph.

Market crises can create the investing equivalent of steam pipe explosions. Investors get caught between two competing pyschological forces that build up pressure:

On one hand, uncertainty causes indecision.

But on the other hand, when we are anxious, we naturally feel a need to do SOMETHING.

The result of these two psychological forces work against each other until -- Kaboom! -- the pressure becomes too much.

It's a vicious cycle and it goes something like this: Do nothing (and suffer), do nothing (suffer some more), continue to do nothing (suffer to the breaking point) then PANIC!!! (do something rash).

It's a wealth killer.

We need a way to let off steam, so that the pressure doesn't build to the point of explosion.

Now, let it be said that we don't give specific advice to investors here at MarketPsych.

Nonetheless, there are some tricks that people often employ to relieve the pressure.

One of the best pressure valves we have is to sell a small percentage of certain positions to free up some cash.

This works on a financial level, but more importantly it works on an emotional level.

Why does it work?

1) It fulfills a deep-seated psychological need to do something, to take back control of our lives.

2) It creates something safe. It lets us know that at least part of the money that was at risk, is now safe. We have less exposure to pain.

3) It gives us freedom. We now have money that we can put to work on our terms. Emotional forces can no longer compel us to sell what will we have already willingly sold.

4) It's a hedge against regret. We all have the same nausea-inducing fears of regret: E.g. "The moment I sell, the market will bottom out" or "It's going to keep going down, and I'm going to hate myself for riding it to the bottom." Selling a small percentage mitigates this crippling fear.

5) It allows us to reframe crises as opportunities. We know that market panics create opportunities. The problem for so many people is they simply don't have the cash available to take advantage of those opportunities. The ability to engage other parts of our brain is another fear-fighting tool that helps put investors back on a healthy investing track.

How much is enough? 1%? 5%?... 20%? Only you can decide. Sit down with your advisor and see where you stand.

If you would like more information on our trainings, please feel free to contact us.

In the meantime... good luck out there.

Frank

Keeping Your Cool in a Panicking Market

The market appears to be crashing (in an orderly way) as I write this.

On the NYSE, New Highs = 1, New Lows = 1000. The VIX is over 55. Our MarketPsych Fear index is the highest ever.

If you're an active investor, what should you do?

Here's an NPR Marketplace interview with me about this.

1. First take a deep breath.
2. If you can't think clearly: go exercise, change your pace, play with your dog.
2. Now orient to where prices currently are. Forget about where you bought a position, or how much it is down. Right now, prices are what they are. And the first source of mistakes is being unable to come to terms with where things are right now.
3. Now, if your holdings are still hurting you, then take some action. You can't think clealy until you stop the bleeding. That doesn't mean sell everything. That means consider selling a small portion of a very painful position to relieve the pressure.
4. But now come back and consider that this is a historic time to find bargains in the market.

For example, if you believe that financial catastrophe is coming (and you have logical reasons for believing this), then gold is usually a good bet. Recently gold mining stocks have fallen in tandem with other stocks (yet their profits will be greater in an inflationary environment).

If you believe deflation is coming, consider this statement: "During deflationary environments, equities have performed poorly; however, high-quality fixed income has performed well." This powerpoint is a primer on managing investments during deflationary and inflationary environments.

Keep in mind that the best investments going forward will often be in stocks that you probably haven't heard of. And corporate bonds may perform better than stocks.

A stock screen looking for companies with high cash levels (and little debt) is sure to find some great opportunities in both stocks and bonds.

Distressed debt and preferred stocks currently have high yields, and you are likely to be very happy about owning these going forward. Also consider convertible bonds. A bond screener (such as at Yahoo Finance), can help you locate these.

If you've ever considered buying Google shares, it's cheaper now than in the past 2 years: $371/share. And they have $12 billion in cash to use to buy cheap and washed out companies.

Remember:

Tune in to your internal sense of balance first. Stabilize your mind first, and only then begin the process of sorting through the rubble.

In general, you don't NEED to do anything. However, sometimes inertia can cost you if you're not well-positioned.

And keep in mind that it's always good to keep cash available for bargain shopping.

Richard

Disclosure: I own several gold mining stocks as a short-term trade (but I don't believe financial catastrophe is coming).