Swedroe: Avoid Investment Depression

December 31, 2015

As the holidays conclude and the calendar turns into a new year, depression can become an all-too-real possibility. After all, the daylight hours are shorter, and what seems like the longest and coldest (at least in some places) stretch of winter is still ahead.

It’s a common time of year for depression, which is frequently described as feeling unhappy, miserable or down in the dumps. Many people have felt this way at one time or another for brief periods. It’s normal.

Most of us, however, are able to prevent a snowballing effect, and we can avoid sinking into clinical depression. Clinical depression is a mood disorder in which feelings of sadness, loss, anger or frustration interfere with everyday living for weeks or more. It is caused by a downward spiral into worry and anxiety, rendering our brains unable to right themselves.

Fortunately, there have been major advances in neuroscience (the study of how the circuits in our brains work). These many advances have helped us understand how to address this problem, not only through medical treatments (such as pharmaceuticals) but through behavioral changes that alter the way our minds work.

We’ve learned that altering behaviors can help avoid a downward spiral and create an upward one. That’s what a wonderful new book, “The Upward Spiral” by Alex Korb, is all about.

Fighting The Negative

As Korb described what happens to those who get sucked into a downward spiral, I was continually reminded about the conversations I’ve had with investors during bear markets. I found that, quite often, the only light at the end of the tunnel many investors could see was the proverbial headlights coming right at them.

Their tendency was to focus only on the negative news. They would anticipate everything that could go wrong, and end up in a loop of worry and anxiety that would lead at best to indecisiveness, and at worst to panicked selling.

Bear markets will cause almost all of us to worry to some degree or another. One reason is that—no matter who we are—our brains are programmed to react more strongly to bad news than to good news.

We feel the pain of a loss much more strongly than we feel the joy of an equal sized gain. Negative emotions dominate positive ones. The difference between people who suffer temporary “investment depression” and those who suffer “clinical investment depression” is that the first group doesn’t get stuck in a feedback loop of worry.

In his book, Korb provides some simple actions we all can take to avoid sinking into a loop of worry. Based on my experience, they can not only help you deal with the problems that life throws your way, but they can help you become a better investor as well. Given that about the only certainty in investing is that there will be more bear markets, the following tips can prove helpful in avoiding panicked selling (one of the keys to Warren Buffett’s success).

Korb explains: “When your mood gets worse, so does your brain’s negative bias. Feeling down means you’re more likely to notice negative things about the world.” Remember that battles are won in the planning stages, not on the field itself.

Escaping The Clutches Of Clinical Investment Depression

  • Exercising. It “makes you mentally sharper and better at planning and decision making.” It also improves your mood, reduces anxiety and decreases stress. And exercising in pleasant environments—at a park or around a lake instead of on a treadmill—boosts the benefits of exercise. In fact, Korb writes, “Irrespective of exercise, being in nature or even just looking at views of trees or lakes can have a big impact on your mood and reduce depressive symptoms.”
  • Take a deep breath. According to Korb, “Inhaling and exhaling slowly actually calms down the sympathetic nervous system and reduces stress.”
  • Focus on what you can control. It “helps modulate your brain activity and reduces anxiety.” While you cannot control what the markets will do, you can control your investment behavior. You can stick to your well-thought-out plan, one that should have included provisions for the virtual certainty that there were going to be bear markets and for rebalancing (buy more stocks, not sell) when they occurred. You can also recall Warren Buffett’s advice that you should avoid timing the market, but if you cannot resist that temptation, at least be a buyer when others are engaged in panicked selling.
  • Avoid catastrophizing. Anxiety can be “exacerbated by envisioning the worst possible scenario. It usually starts with a perfectly reasonable worry, and then, through incorrect assumptions, it snowballs out of control.”
  • Imagine optimistic outcomes. Just “imagine the possibility of positive future events. You don’t have to believe they will happen, just that they could.” Simply imagining good outcomes activates the parts of the brain that helps control negative bias. In moments of crisis, you have to get your mind off of what’s bothering you and onto good things. People in depression—including investment depression—cannot do this.

In my role as an investment advisor, I have found that there are two things I can do to help investors both avoid catastrophizing and imagine optimistic outcomes. The first was to point out the lessons history has provided.

Envision Good Outcomes

While there is never a guarantee of a good outcome, looking back at bear markets we have experienced in the past, and their aftermaths, can help investors envision a good one.

For example, during the 1973-1974 bear market, the S&P 500 lost more than 37%. Over the next 25 years, it went on to return 17.2% a year. Perhaps recalling this outcome could have helped avoid panic during the more recent financial crisis of 2008-2009.

When the “flash crash” occurred on May 6, 2010 (and the Dow Jones industrial average (DJIA) fell more than 1,000 points), remembering what occurred after “Black Monday” may have helped avoid panicked selling.

On Oct. 19, 1987, the DJIA fell more than 500 points—a drop of almost 23% in just that single day. By the end of that month, the DJIA had gained back more than half of that loss, and from November 1987 through December 1991, the S&P 500 Index returned 16.9% a year.

We have recovered well following every single bear market since the Great Depression. Investors who panicked in March 2009 when the S&P 500 Index hit a low of 666 and got out of the market missed out on the greatest rally since the Great Depression. From March 2009 through September 2015, the S&P 500 Index returned 18.2% a year. Simply recalling this outcome can help you avoid panicked selling in the next one.

There is a second strategy that can help you avoid catastrophizing.

Engage In Stage-Two Thinking

As is explained in my book, “Think, Act, and Invest Like Warren Buffett,” one of the keys to Warren Buffett’s success as an investor is that he avoids a human tendency to engage in what Thomas Sowell called “stage-one” thinking.

Those who engage in stage-one thinking see a crisis and the risks, but cannot see beyond that. Their stomachs take over, they cannot control their emotions, and they get into a downward spiral until eventually panic sets in—leading to the abandonment of even well-developed plans.

On the other hand, Warren Buffett engages in “stage-two” thinking. He expects that a crisis will in turn lead governments and central bankers to come up with solutions to address the problem. While he doesn’t know specifically what those actions will be, he envisions possibilities, such as cutting interest rates, cutting taxes, increased government spending or buying bonds.

In addition, he knows that the greater the crisis, the greater the response is likely to be. That allows him to see beyond the crisis at hand, enabling his head to keep control over his stomach and his emotions.

Summary

The field of behavioral finance, the study of human behavior and how that behavior leads to investment errors—including the mispricing of assets (what are called anomalies)—is a fascinating one.

The findings from research in this field have helped us gain useful insights with regard to the errors of judgment made by investors—errors that penalize results. And the fields of psychiatry and neuroscience have made other advances that can help us not only lead healthier lives, but to be better investors.

I recommend picking up a copy of “The Upward Spiral,” as it not only might help you become a better investor, but it might help you win the more important game—life.

For those interested in learning more on the subject of neuroscience—how our brains work—and its impact on investment decisions, I highly recommend Daniel Kahneman’s “Thinking, Fast and Slow” and Jason Zweig’s “Your Money and Your Brain.”


Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.