In today’s Wall Street Journal, former Federal Reserve Chairman, Alan Greenspan, discusses the financial crisis and what led to it. (Alan Greenspan: What Went Wrong by Alexandra Wolfe) I was interested in several observations he made, but wanted to spend today’s blog opining on one of the sections from the article and how it applies to some of the recommendations I see being made on a regular basis in the investing arena. It is well known that investor returns are far lower than markets have provided throughout history. Much of it has to do with psychological factors that I’ve outlined on many occasions. One of them is our desire to not lose money versus our desire to make money. This is how Mr. Greenspan addresses this in the article:
“Mr. Greenspan set out to find his blind spot step by step. First he drew the conclusion that the nonfinancial sector of the economy had been healthy. The problem lay in finance, because of its vulnerability to spells of euphoria and irrational fear. Studying the results of herd behavior provided him with some surprises. “I was actually flabbergasted,” he says. “It upended my view of how the world works.”
He concluded that fear has at least three times the effect of euphoria in producing market gyrations. “I wouldn’t have dared write anything like that before,” he says.”
I guess I must have taken a psychology class at some point and learned this, because I’ve mentioned this many times on my radio program.
This human trait is why annuity sales are so brisk right now. The vast majority of sales of annuities are terribly inappropriate, overpriced, costing thousands to tens of thousands in commissions that come, not from the insurance company as salesmen have tried to lead people to believe, but from the investor’s account. They cause people to pay for a benefit (tax deferral) that IRAs provide for free, have excessive insurance costs, give people a false sense of security (market collapses will take insurance companies down too). Besides that, they’re okay.
From a marketing perspective, however, people will respond to something that will supposedly take away the fear of loss far more than they will respond to something that will give them gain. The irony is that they simply shift to another risk. They don’t get rid of it at all. Historically, Treasury bills have been considered risk-free investments. The average rate of return of T-bills (as we call them) is 0.5% above inflation from the 1920’s until now. If the investment in which they are held is taxable, that means an almost certain loss of money over time. That is about as close to a guarantee as we can get in investing.
Emotions are a powerful deterrent to successful investing and now the former Fed Chairman knows why.
