Investor emotion beginning to shift toward glass half full

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There’s been a quick turnaround in the psychology of investors, said Bryan Olson, head of portfolio consulting for Charles Schwab & Co. Inc. He likens it to the analogy of pushing a spring down – when it’s released, it springs back hard.

Clients and investors definitely have “better attitudes” about the market, and Olson sees more separation between the “three camps” of investors.

A small percentage are “wildly optimistic” and ready to buy tons of equities because life is wonderful again.

Another small percentage is firmly on the downside and cannot shake it off – as in, how can we buy gold bullion and the market’s going to get worse and never recover.

But the largest group is middle ground and sees the market as recovering and almost – key word, almost – back to normal.

“Psychology hit an all-time low in March,” Olson said. “The correlation between investor sentiment and market swings was almost immediate – hourly.”

During the past, there was a much longer lag. Investors “let their mood be dictated” by quarterly returns, or even six-month or annual returns.

But that’s so old-school. Why live a normal life when you can swing on the rafters and crash in the basement several times all in one day? But I digress.

No doubt investors tire of being reminded that investing is for the long-term. But it bears repeating because human psychology is geared toward fight or flight for physical survival.

Which doesn’t exactly translate well to investing.

Historically, fleeing the market guarantees that an investor will miss the triumphant upswing, Olson said.

The U.S. economy has had 15 bear markets since 1926, he said. And each time, during the 12 months following the bottom of the bear market, the average returns were 45 percent.

“So if you’re sitting around waiting to feel better before entering the market,” Olson said, you’ll miss the best of the recovery because the market is a leading indicator of recovery, and jobs and the economy are lagging indicators of recovery.

“The velocity of the upside often equals that of the downside,” he said.

So, if you miss the first three months of that 12, your return drops to 32 percent. And if you wait six months to enter the stock market, your return drops to 19 percent.

“Market recoveries are often front-end loaded,” Olson said.

For instance, from the “ultimate low” (of this recession) on March 9, the market was up 30 percent by the first week of June.

And keep in mind that a diversified portfolio includes bonds.

A “moderate” portfolio is 60 percent equities and 40 percent bonds and other assets, Olson said.

“Bond rates are low, now, so that’s a challenge,” he said. “But bonds serve a couple of purposes.” They can provide income, when rates are high, and they provide protection and stability.

On the corporate side, the risk of bonds is heightened, but “diversification is important on the bond side of a portfolio, just as it is on the equities side.”

Government bonds are, of course, the safest, but currently the lowest-yielding.

And because “we cannot have this much stimulus without inflation sometime in the future,” Olson recommends Treasury Inflation-Protected Securities bonds.

“They’re ultimately safe because it’s the government and they have a built-in kicker to adjust for inflation,” Olson said, “providing safety for a portfolio.”

Finally, Olson has seven keys to tempering one’s psychological reactions to the market, in order to build a better portfolio:

Understand your emotions and behavioral tendencies – because humans are “overconfident” and have a perfect ability to “predict” only in hindsight.

Create a plan: Articulate your goals, risk tolerance and investment philosophy, he said.

Broadly frame a definition of “success” in your portfolio by comparing it to the plan.

Be realistic about the odds of gains and losses.

Understand all forms of risk and long-term market history.

Ask for help from a consultant who understands the “unique” you, Olson said.

And continually monitor and adjust your portfolio – and attitude – as necessary.

Rebecca Tonn covers banking and finance for the Colorado Springs Business Journal.