Fear can lead to irrational investing

By DAVID MOON, Moon Capital Management, LLC
October 7, 2012

We’ve all seen it; most of us have done it, although not to the point of disastrous consequences. A car lying on the side of the road after the driver jerked the steering wheel to the left, violently overcorrecting his right tires after having drifted off the road.

It is a common reaction to fear. We overreact, often placing ourselves in a jeopardy far worse than the one we initially perceived.

And we do it with our money as often as we do it anywhere else in life.

In our rush to slam shut the barn door after the cows have escaped, we often break the hinges.

It’s bad enough that many of us are wired to abandon reason in the face of our fear, but the investment industry is full of people trained to prey on that all-too-natural emotional response.

Sometimes our fear is that we will miss “the next big thing.” Those who feed on these fears give us things like IPIX and IdleAire.

The irrational fear of loss gives rise to advertisements featuring promoters claiming that their clients never lost money in the 2008 market collapse, yet still offering securities with competitive rates of return.

What's the catch? Promoters justify these types of claims by saying you don’t lose any money if you don’t sell your investment. Or it depends on what your definition of "competitive" is or some other fine print qualifier.

In the two weeks ended September 19, investors moved more than $16 billion into long-term bond funds, while moving almost $10 billion out of stock funds. That is the definition of an irrational response to an emotional fear. No rational long-term investor would buy long-term bonds at today’s rates.

The yield on a ten-year US Treasury bond is currently 1.625 percent. Once inflation is considered, that guarantees the owner a loss in purchasing power over the life of the bond. A thirty-year Treasury only yields 2.80 percent, locking in for an investor an almost guaranteed three decades of inflation adjusted losses.

What are the odds that an investment in the S&P 500, at 15 times earnings, will earn less than three percent annually for the next 30 years?

If future investment prices were simply a continuation of past trends, successful investing would only require the use of a ruler – to draw a line extending the past trend into the future.

Of course, to extrapolate Treasury bond yields into the future, you’d have to assume yields drop well below zero percent. Yields may go to zero, and they may even irrationally dip below zero on brief occasions, but ten years from now the yield on newly issued 20-year Treasury bonds is not going to be negative 5 or negative 10 percent.

That’s what a continuation of the prior trend requires. And that’s what those people moving money from stocks to bonds are counting on, whether they realize it or not. Their fear is driving them to do it.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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