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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Market testing investors’ psyche

Investors understand well the concept of buying low and selling high, yet constantly violate that most basic of Wall Street rules because emotion overrules intellect, Washington State University Professor John Nofsinger said Friday.

The author of “The Psychology of Investing,” speaking at the end of a disastrous week for stocks, said people project into the future what they have experienced in the present and immediate past because that is what they know. This “extrapolation bias” causes them to throw money into a surging market, and pull out when the trend reverses, he said.

Nofsinger noted investors poured money into mutual funds toward the end of the bull market of the 1990s, then withdrew – with terrible losses – when the dot-com bubble burst. The Dow Jones industrial average tumbled from about 11,500 in October 1999 to about 7,600 by mid-2002, when a new bull market began.

Echoing the advice of many an investment adviser, Nofsinger said investors must maintain a reference point distant enough that short-term market fluctuations do not allow impulse to overcome reason.

He said researchers are just beginning to understand some of the psychological mechanisms that drive decision-making that defies reason; familiarity with a name brand, for example.

He said people want to be comfortable with their investments, and a name like Google or Harley-Davidson can be reassuring even before an investor looks at price-earnings ratios or other fundamental measures of company performance. If they look at all, Nofsinger said.

Investing, he added, is not done in a vacuum, and the financial pressures created by falling home prices and higher gas and food prices feed the market negativity. Mudslinging presidential campaigns would not help, he said.

Research has shown stocks do better for no better reason than the sun is shining, said Nofsinger, who has been asked by Psychology Today magazine to blog on the investor psyche. He said he expects to start next month.

At the Financial Industry Regulatory Authority, Vice President for Education Geraldine Walsh cautioned investors against risking assets they cannot afford to lose in an attempt to make up for market losses.

Nervous investors are more vulnerable to fraud, Walsh said, or the temptation to pull back on contributions to 401(k) plans or Individual Retirement Accounts. Worse, they might make premature withdrawals, or borrow against those accounts for expenditures best not made in the first place, she said.

FINRA, in conjunction with AARP and the Washington Department of Financial Institutions, has been conducting an investor education program in Spokane intended to arm seniors against scams. Results are still being analyzed, but a preliminary assessment indicates the effort was successful, she said.