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Fallout: The Financial Crisis

Putting investors on the couch

Marketplace Staff Oct 3, 2008
Fallout: The Financial Crisis

Putting investors on the couch

Marketplace Staff Oct 3, 2008


Tess Vigeland: Psychiatrist Richard Peterson isn’t going to tell you it’s all in your head. No, the monsters in the closet are real. If you want to know what they look like, just check your investment portfolio.

But as a hedge fund manager with an MD, he will tell you that you those monsters can’t get you unless you let them. It’s all about keeping a clear head to avoid your own meltdown.

To do that, we asked him to put Wall Street on the couch and psychoanalyze the market and us.

Richard Peterson: Thank you.

Vigeland: In your business as a hedge fund manager and a psychiatrist who studies these things, what are we all doing right now in our heads as we watch this happen?

Peterson: Essentially, when prices drop as steeply as they have, most people become more afraid and it actually changes the way that they think about the markets. So these things are a result actually of our brain chemistry. It’s a response to watching prices drop.

Vigeland: And how do we tend to react to that? What do we do?

Peterson: Depends. To some extent, people will avoid thinking about it, avoid checking their stock portfolio. At some point though, when the pain becomes too much, many people will log into their 401(k) plan website, look at the value and say, “I can’t take it anymore” and then they’ll panic and sell.

Vigeland: Which is the exact opposite of what you want to do. You never want to sell on the down side.

Peterson: That’s what we’ve learned over the last couple centuries in the United States, but unfortunately it’s not always true. In fact, if you were in pre-war Germany or Japan, you probably didn’t want to be holding any stocks. So there are very rare cases in history, but you’re right: in general, you do want to hold through the down times.

Vigeland: On your website, one of the headlines that you have there is “Fear Index Highest in History.” Tell us about the Fear Index.

Peterson: Well, we have the MarketPsych Fear Index which measures words like “fear”, “panic”, “anxiety” used in relation to investors in the financial media. For example, a headline says, “Investors Panic Today,” then we would pick that up and we’d score it. And we found that over the last 26 years that we’ve been keeping track that in fact our Fear Index now is higher than it’s ever been — higher than the 1987 crash, higher than after 9/11 — and it appears that it’s probably the highest since the Great Depression, since 1929.

Vigeland: Then how do you explain to people what’s going on without contributing to a panic? People see that and don’t they just freak out even more?

Peterson: What we like to do is we show it to people and we say look, every other time that it peaked as it’s doing now — right now it has a very sharp acceleration peak — and we say look at stock prices. It was always a great time to buy over the next several years. But for most of us, the fear change… like I said, it changes the way we think. Our stress hormones — cortisol — causes us to see only day-to-day price action and to feel like it’s very relevant for us. This is done for a good evolutionary reason, which is that if we experience stress, we want to make sure we know where all the threats are in our environment. But the reality is that’s exactly the wrong type of thinking for this type of environment. You really need to be expanding your horizon, looking at the long term.

Vigeland: You are a psychiatrist. Put me on the couch and tell me how I deal with that fear, that growing fear, that sense that I’m now following every single little thing that could go wrong. How do I fight that so that I don’t make the wrong decisions?

Peterson: Well, the first thing is to make sure that you don’t make any rash moves right now. Get into a position where you can be analytical and that is really hard to do…

Vigeland: How do you do that?

Peterson: Well, what I would say is make sure you’re getting your exercise, you’re eating right, take some deep breaths…

Vigeland: Really? The basics?

Peterson: The basics. Think about your family. Are you happy and healthy right now? Think about the things in your life that you enjoy. Get yourself out of the fear frame. Think about that house that you want in retirement. Do you want a 4 bedroom/3 bath house on the lake? If you want to respond to your short-term fear now, you might be missing out on that longer-term gain.

Vigeland: Well you talk about the fear that is involved here and I wonder how do people get away from that? What is going to bring them back?

Peterson: People have to like what they’re going to buy and they have to feel like it’s really cheap, like it’s a good bargain. Those are two separate areas of the brain. If you can activate one of those — get people to really like something or make it really cheap so they think it’s a good deal — that’s how you get people to buy, and it kind of explains why you see the carpet store that always says “Going out of business.” There are a lot of opportunities out there. There’s a lot of cheap stocks, there’s a lot of stocks selling at a discount and at the same time, there’s a lot of really neat companies. The problem is when people are owning something already, one reason they might need to sell it and buy something new is they don’t like what they owned that’s been dropping. They don’t like it anymore. Why would they put more money into that mutual fund? They’re not even thinking. So they’ve got to change tactics, they’ve got to get out of that mutual fund and look for something else, look for another story, another something that can motivate you.

Vigeland: Dr. Richard Peterson is a founder of MarketPsych. It’s a hedge fund that makes investments based on the psychology that we’ve been talking about here, and he’s also a practicing psychiatrist. Thanks so much for coming in.

Peterson: You’re welcome Tess.

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