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Wade W. Slome, CFA, CFP
Wade W. Slome, CFA, CFP
Articles (110) 

Sitting on the Sidelines: Fear & Selective Memory

October 27, 2013 | About:

Fear is a motivating (or demotivating) emotion that can force individuals into suboptimal actions. The two main crashes of the 2000s (technology & housing bubbles) coupled with the mini-crises (e.g., flash crash, European crisis, debt ceiling, sequestration, fiscal cliff, etc.) have scared millions of investors and trillions of dollars to sit on the sidelines. Financial paralysis may be great in the short-run for bruised psyches and egos, but for the passive onlookers, the damage to retirement accounts can be crippling.

Selective memory is a great coping mechanism for those investors sitting on the sidelines as well. Purposely forgetting your wallet at a group dinner may be beneficial in the near-term, but repeated incidents will result in lost friends over the long-run. Similarly, most gamblers frequenting casinos tend to pound their chests when bragging about their wins, however they tend to conveniently forget about all the losses. These same reality avoidance principles apply to investing.

A recent piece written by CEO Bill Koehler at Tower Wealth Managers, entitled The Fear Bubble highlights a survey conducted by Franklin Templeton. In the study, investors were asked how the stock market performed in 2009-2012. As you can see from the chart below, perception is the polar opposite of reality (actual gains far exceeded perceived losses):

franklin-templeton-loss-survey.jpg?w=102Source: Franklin Templeton via Tower Wealth Managers

With so many investors sitting on the sidelines in cash or concentrated in low-yielding bonds and gold, I suppose the results shouldn’t be too surprising. Once again, selective memory serves as a wonderful tool to bury the regrets of missing out on a financial market recovery of a lifetime.

Humans also have a predisposition to seek out people who share similar views, even though accumulating different viewpoints ultimately leads to better decisions. Morgan Housel at The Motley Fool just wrote an article, Putting a Gap Between You and Stupid, explaining how individuals should seek out others who can help protect them from harmful biases. A scientific study referenced in the article showed how the functioning of biased brains literally shuts down:

“During the 2004 presidential election, psychologist Drew Westen of Emory University and his colleagues studied the brains of 15 “committed” Democrats and 15 “committed” Republicans with an MRI scanner. Each group was shown a collection of contradictory statements made by George W. Bush and John Kerry. Not surprisingly, the partisans were quick to call out contradictions made by the opposing party, and made up all kinds of justifications to rationalize quotes made by their own side’s candidate. But here’s what’s scary: The participants weren’t just being stubborn. Westen found that areas of their brains that control reasoning and logic virtually shut down when confronted with a conflicting view of their preferred candidate.”

Rather than letting emotions rule the day, the proper approach is to stick to unbiased numbers like valuations, yields, fees, and volatility. If you continually make mistakes; you aren’t disciplined enough; or you don’t like investing; then find a trusted advisor who uses an objective financial approach. Opportunistically taking advantage of volatility, instead of knee-jerk reactions is the preferred approach. For those people sitting on the sidelines and using selective memory, you may feel better now, but you will eventually have to get in the game, if you don’t want to lose the retirement account game.


Wade W. Slome, CFA, CFP[b]®[/b]

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is the information to be relied on in making an investment or other decision.

Rating: 3.6/5 (8 votes)


AlbertaSunwapta - 3 years ago    Report SPAM
I fear that four years into a recovery the timing and not the wisdom of articles like this convince those that have been fearful (maybe rightly so) to now act imprudently as they fear instead that they're missing the boat.

Having jumped back into the market at its depths in early 2009 I have become increasingly cautious over the past year. As the greed rises again, I'm becoming increasingly fearful. Four years ago it seemed only Warren Buffett warned of holding cash and few listened then. After double digit returns fears of losses dissipate and are now being replaced by fears of lost opportunity.

However, admittedly, over the last month I too have bought back into a few fairly valued, though not cheaply valued positions as sitting with cash takes a whole lot of conviction. (It's not always fear of the past causing people to sit on their cash.)

Additionally, gold is mentioned above. I believe gold investors have done quite well over the past decade. Until recently they've very likely beaten my equity returns. Again, I have to question whether gold investors were acting on fear or a better sense of reality than I possess.
SeaBud premium member - 3 years ago
There is no reason to fear "timing" from an article like this if you take all "fear" out of the equation. A stock is either undervalued, correctly valued or overvalued by Mr. Market, and it is up to the investor to make that call regardless of fear or what the market is doing (in 2009 or now). I am not cautious now because of greed rising, I am cautious because valuations are rising - which has led me to sell some consumer cyclicals when p/es exceeded 21. On the other hand, I'm buying some energy stocks. All in all, couldn't care less about fear or greed.
AlbertaSunwapta - 3 years ago    Report SPAM
^ Ahh, admirable points, most literal one.

Some quotes from a more colloquial one:

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." - Warren Buffett

"Be fearful when others are greedy, and be greedy when others are fearful". - Warren Buffett
Vgm - 3 years ago    Report SPAM
Agree with the article and Seabud in that logical-rational behavior is what's called for at all times.

Buffett and particularly Munger talk often about the advantages of remaining unemotional and rational in investing. Valuation is the indispensable compass, as Seabud says.

When Buffett recommends being "greedy" or "fearful", he's speaking figuratively, not about runaway emotions we cannot control. It's the crowd and Mr Market who get emotional and push prices up and down, often irrespective of valuation.

Furthermore, when engaging in contrarian behavior, we should remember Ben Graham's advice:

"You are neither right nor wrong because the crowd disagrees with you. You're right because your data and reasoning are right."
AlbertaSunwapta - 3 years ago    Report SPAM
^ yes exactly. Don't take figurative speech literally.

Also one has to look rationally and logically to the timing of additions to their own knowledge base. Much knowledge and wisdom comes with age and experience. In other words, much "wisdom" occurs after the fact. This creates the risk that the application of a new skill or insight will be ill-timed. Like the proverbial bolting of the barn door after the horses have escaped.

So as Buffett has said, temperament plays an important role in investing success. The question is thus: Can those whom have shown inappropriate temperament (i.e. fear) at some point over the past four or five years or more be expected to suddenly make the conversion to being rational and logical? I don't think its that easy. As such value investing, buy and hold and other such articles that offer great wisdom are "bought into" with the confirmation of high near term historical returns. When the market turns, those recent converts abandon their newly adopted "rational" thinking and again sell into fear. They have to fight their own intrinsic temperament.

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