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INVESTOR PSYCHOLOGY, FINANCIAL SCAMS & A NEW YEAR
"Why We Keep Falling for Financial Scams" by Stephen Greenspan uses the recent Ponzi scheme by Bernard Madoff as a springboard for discussing several historic schemes, followed by Greenspan's discussion of the psychological reasons people who should know better are drawn to these mistakes. He is a psychologist who specializes in gullibility. The most notable scam I remember in Knoxville was by Joseph C. Taylor, whose Ponzi scheme ended with his death in 1995. Fortunately there was little direct impact to people close to me. However, I believe Greenspan's article is worth reading because it also probably sheds light on many of the factors that lead people into legitimate, but erroneous, investments like the 2008 collapse of Idleaire. It seems possible to me that his explanations may also have relevance to the reasons people buy stocks in times of "irrational exuberance," when prices are almost certain to fall. The times people sell most of their stocks at the very bottom of bear markets probably have similar roots. The article can be found at "Why We Keep Falling for Financial Scams". A NEW YEAR HAS BEGUN We are preparing December 31 Quarterly Reports. The last year was difficult for almost everyone - particularly October and November. Many have decided they simply do not want to look at their brokerage statements. I can suggest you may want to at least notice that most stock portfolios should have positive returns for December. The S&P 500 Index return was +1.06% for the month. This is cautiously encouraging, even though the quarter and year returns are still substantially negative. Another encouraging observation from December is the dramatic reduction in day to day volatility. Through October and November, daily swings of a few hundred points for the Dow were very common and difficult. For the most part, those swings really went in both directions, even if they felt like they were always down. There are many stories of people who sold whole portfolios under feelings of extreme stress during this time. And, of course, there are people who "claim" they sold everything last winter or spring, missing the declines. In late November and through December, we were able to use the relatively less volatile market to move money among mutual funds for tax advantages. Plotting the transactions to capture the future tax savings and preserve our investment style was a major part of Bryan Hankla's work in December. Dividend payments during the month made the job even more difficult. He and I often discussed the more difficult decisions. The market has fallen so far, many very good mutual funds bought in the last couple of years were worth less than their original costs. By replacing those with similar funds in 2008, our clients have realized losses, which can be used to offset capital gains for tax purposes. Even if there are no capital gains in 2008, the losses can be carried forward on future tax returns, until future capital gains deplete the amount. Those future capital gains can come from any source - like capital gains distributions from mutual funds, as well as the sale of a business or real estate that has been owned many years. We executed similar transactions during the 2000 to 2003 bear market, which essentially rendered some clients' capital gains tax free for several years. Until there are capital gains to reduce these capital losses that are being carried forward, clients can generally deduct $3,000 per year against ordinary income, which currently has higher tax rates than capital gains. We must all keep a clear understanding that this relative daily stability and one month of positive return is not a sign that all the troubles are over. The Bulls and Bears are still standing toe to toe - negotiating - with each holding completely different opinions for which way the markets will go next. They are both well informed and intelligent. Some are probably more optimistic than they should be. Some are probably more pessimistic than they should be. It has always been this way. None of us can personally know whether we are too optimistic or too pessimistic at any given time. There is always someone as smart or smarter, who believes just as strongly that they are right. And, there is always the possibility of another event that no one could have expected. I recommend reading the Greenspan article, "Why We Keep Falling for Financial Scams," as you ask yourself whether you can set the feeling he describes aside to make more rational investment decisions in the future. I can attest that this is a difficult job for even the most seasoned investors. Sincerely, |
LIBRARY TOPICS More Than Money Newsletter - Volume 5, Issue 2
Yes, whenever the market for beef or stock is falling, someone is still buying, with the belief they have a bargain. Very soon, the bull and the bear will both know who was right – at least for a moment or two.
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