Behavioral Finance

Is investor psychology shifting?

Interview with Dr. Glenn Freed

Key Takeaways:

  • Top advisors prevent clients from taking on too much risk and work diligently to extract clients’ emotions from their investment decisions.
  • The “new normal” of the economy and equity markets is being driven by the amount of intervention by governments and central bankers.
  • Discipline is what allows investors and their advisors to make decisions under duress.
  • The key to a fulfilling life is managing risk, embracing uncertainty and enjoying the ride.

We recently caught up with Dr. Glenn Freed, CEO & Chief Investment Officer of Vericimetry Advisors LLC in Los Angeles to get his take on the market’s direction near term and how investor psychology may be changing in the wake of macroeconomic and geopolitical events.

Glenn, has investor psychology started to shift again? The markets are at or near all-time highs. Housing, employment and consumer confidence are better than at any time in the past four to six years. But the Fed stimulus program might be ending, meaning higher interest rates.

An elite advisor’s job is to manage both the peaks and valleys of clients’ behavioral biases. With the bull market we have just experienced, investors start to get short-term memory lapses. In particular, greed kicks in and investors become inclined to move all their assets into equities. The advisor must help clients refrain from taking too much risk. To this end, the advisor should work to extract clients’ emotions from their investment decisions.

On a scale of 1 (total fear) to 10 (total greed), where would you say we are today on the fear/greed index?

I think where we are on the “index” is really a question of where the average investor is on the scale. Clearly, greed has kicked in, but some investors still live in fear from their memory of the markets of 2008 and 2009. Looking at the question from a different angle, we should ask, “Is the index’s standard deviation higher today?” The answer to that question is yes! This means that an advisor has to ask clients the right questions and take them down “memory lane.” In the end, the advisor must obtain high-quality information about clients in order to provide them with the appropriate advice. Profiling the client investment psyche has become harder because of the recent extreme markets and geopolitical events that the media constantly reminds us about.

Over the past half-decade or so, financial markets flourished while most of the economy suffered. Is this “decoupling” between the markets and the economy the new normal or just a temporary aberration after such a catastrophic recession?

The market always tries to anticipate—and be a leading indicator of—where the economy is heading. I think the new normal of the economy and the equity markets is the amount of intervention by governments and central bankers. It is difficult to forecast where the economy or the markets are heading with so much intervention from these powerful actors. Such intervention creates uncertainty about where the market is headed in the near future. As an example, look at the recent uncertainty in tax policy that drove business decision-making to a standstill at the end of 2012. The new normal of decoupling is a symptom of unusual and uncertain intervention by governments and central bankers.

For more than a decade investors loved emerging markets. But with instability in the Middle East again and weakening currencies in many emerging markets, is now the time for U.S. investors to start paring down their exposure?

Emerging markets are not for the faint of heart. Those emerging economies have greater risk and uncertainties than economies in the developed world do, so investors must be able to have a long enough investment horizon to live through the emerging markets’ business cycles. However, from adversity comes opportunity. Disciplined long-term investors should run toward, not away from, the adversity of emerging markets.

Is there ever a good time to abandon your “discipline” and explore a new strategy for investing on behalf of your clients?

Discipline is the key to smart decision-making. An advisor should do scenario planning for all possible future investment outcomes and make investment decisions based on a complete set of possible future outcomes. Discipline allows one to avoid making decisions under duress. If an investor makes a decision under duress, the advisor has failed in his or her fiduciary responsibility to provide that client with the best possible investment advice. When I hear an advisor suggesting a “new strategy” to a client, the advisor has failed to plan for the future that has come to pass. The advisor probably failed to anticipate the events that occurred and did not incorporate the probability for such events in the overall strategy.

Anything else you’d like to share with Elite Advisor Report readers?

If we knew our future with certainty, life would be boring. The key to a fulfilling life is to manage risk, embrace uncertainty and enjoy the ride. Being humans, we find that this is often more easily said than done.

About the Author

Vericimetry is an academically based, quantitatively structured investment adviser providing capacity-constrained asset class strategies to an exclusive group of elite financial advisors. Website: www.vericimetry.com.

Glenn S. Freed, PhD, CPA, PFS, is a leading investment and tax expert in the investment management industry. Dr. Freed is the Chief Executive Officer of Vericimetry Advisors LLC, which intends to make necessary filings to become an investment advisor registered with the Securities and Exchange Commission during 2011. Dr. Freed has 25 combined years of experience in investment management, tax and accounting research, education, and tax advising. He received a PhD from the Graduate School of Business at the University of Southern California and a BS in accounting from the University of Florida.

Phone: (818) 813-1351