The remote server returned an unexpected response: (417) Expectation failed.
The remote server returned an unexpected response: (417) Expectation failed.
Republicans and Democrats in the United States seem incapable of agreeing on anything. In Europe, the search for a solution to Greece’s debt problems has been overshadowed by questions about the continued existence of a single currency for the European Monetary Union.
Add at least a half-dozen crucial elections in 2012 — including ones in France, Greece and the United States — and a political transition in China, and pessimism about what lies ahead seems fairly rational.
Yet a year ago, the outlook for 2011 seemed the exact opposite of what the year turned out to be. Economists were raising their growth projections, consumer confidence was improving and a tax-cut compromise in Congress was putting more cash into pocketbooks. An accelerating economic recovery seemed in the offing.
Of course, that was not how the year turned out. Probably the only investors bragging about their returns are the ones who perfectly timed their purchases of United States Treasury bonds and gold — two asset classes that most analysts said were overvalued as 2011 began. (Of course with gold, the people gloating the most are the ones who sold it at its August peak.)
So how should you think about next year? Should you hide for one more year, or charge forward with some sort of plan?
For this week’s column, I asked a group of people whose opinions have impressed me to ponder this conundrum. Next week, I will share some final thoughts and 2012 predictions from the group of five strategists and investors that I have spoken to each quarter. My hope is that in mixing theory and practice, the two columns will offer investors a better sense of both how they should and will act next year.
THE ENVIRONMENT When Standard & Poor’s downgraded the credit rating of the United States in August, investors rushed to buy Treasury bonds, the very asset that had just become less creditworthy. This might seem utterly irrational, but it did not surprise Daniel Kahneman, the psychologist who won the Nobel in economic science for work that became the foundation of behavioral economics.
“Treasuries just feel safe,” he said. “When you’re worried, you go to the safe thing. It’s quite a normal reaction.”
I called Mr. Kahneman because I had been reading his new book “Thinking, Fast and Slow” (Farrar Strauss & Giroux) and was fascinated by his division of people’s thinking into two systems. System 1 is fast; it’s intuition. System 2 is slower and moderates System 1; it’s the ability to reason.
But what do we do if our System 1 thinks everything looks bleak next year and our System 2 agrees?
“My System 1 also says it is going to be a bad year,” Mr. Kahneman said.
But feeling that does not equate to shunning the market. “I’m not really sure that the situation is very different from what it usually is,” he said. “The same advice about prudence that would carry you in other years would carry you in next year.”
(His greater concern is with what the last three years have done to the general sense of optimism among the young. “That’s a profound change,” he said. “Where that will go, what shape that will take I cannot predict.”)
Practicing a prudent strategy is tougher than it sounds, particularly given the extremes of the last five years. To go from housing and stock markets that were always going up to a housing market that is bumping along the bottom and a stock market that goes up and down seemingly at random is tough to take.
Daniel Egan, head of behavioral finance for the Americas at Barclays Wealth, said that from Jan. 1 to Aug. 1 the Standard & Poor’s 500-stock index moved up or down at least 2 percent on 8 percent of trading days. From Aug. 1 to Dec. 20 that number more than tripled, with 27 percent of trading days having moves greater than 2 percent one way or the other. And 13 percent of the days in the second period had swings greater than 3 percent, compared with none in the first period.
“This is the worst kind of environment to attempt market timing in,” Mr. Egan said. “Odds are, you’ll miss the rally when one or more uncertainties — euro, U.S. fiscal policy, U.S. election — resolves itself, leaving you with the volatility but not the return you’d hoped for.”
SIZING THINGS UP One thing behavioral research has shown is that people who lose a lot of money in a particular asset class will often shun it or at least underweight it as an investment in the future.
“Individuals who got burned by T-bills in the 1970s and were burned by inflation underweighted T-bills the rest of their lives,” Mr. Egan said. “2008 being a credit crisis, people are going to have an experiential prejudice against banks for the losses they experienced.”
He added that people who believed real estate was an investment that would always go up were likely to have similar biases.
Assessing these objectively will be crucial for investors who want to make reasoned decisions. Meir Statman, professor of finance at Santa Clara University, said investors needed to step back and think about how the fear of losing even more money was directing their decisions.
“Fear makes us think the world is coming to an end; it makes us think that stocks will never go up and always go down,” he said. “This is where logic is going to have to intrude.”
One helpful tip from Michael Mauboussin, chief investment strategist at Legg Mason Capital Management and the author of “Think Twice: Harnessing the Power of Counterintuition” (Harvard Business Press), was to assess the experts providing the advice and understand the likelihood that their predictions will be right.
“In some realms, experts will predict very well,” Mr. Mauboussin said. “If you turn on the weather, you can be sure if you need an umbrella. When we’re dealing with economic, political and social areas, we cannot predict as well.”
Robert Seaberg, managing director of planning services at Morgan Stanley Smith Barney, advocates that people be a bit more realistic in their thinking about investments.
“The world now is more about risk management than about investing,” Mr. Seaberg said. “Forget the home runs. Guard against the really big losses, and go for singles and doubles. You win more games than you lose.”
ACTION OR INACTION The collective wisdom of this group is almost entirely to take the long view and stay the course next year.
“My advice to individual people is the less attention you pay to this stuff, the better you are going to be,” Mr. Mauboussin said. “You need to have a prudent strategy, a risk tolerance and a time horizon and then don’t get too caught up in it.”
Of course, the long horizon sounds great if you are at the beginning of it. If you are among the baby boomers in retirement or about to be there soon you may scoff at this. But Mr. Statman, who turns 65 this year, said the last thing people of his generation needed to do was try to find a way to get their money back. They need to live with less.
“The saddest stories I read about are of baby boomers trying to recover their losses by going into risky investments, and they end up in Ponzi schemes or very miserable positions,” he said.
As for Mr. Kahneman, he has no plans of adjusting a strategy that has served him well. “I made one big decision, which was how much I want to have in equities and how important it was for me to be protected from inflation,” he said. “Then I leave it to other people. I don’t even want to know how things are going day to day.”
If it’s good enough for a Nobel laureate, it might be good enough for you.
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Marilynn K. Yee/The New York TimesStephany Kirkpatrick, left, and Mina Black of LearnVest.