lessons from the bear market

Jason Zweig's latest book, Your Money and Your Brain, looks at how the brain responds when making real-life financial decisions. In an interview that appeared on Morningstar.com last week, Zweig, who writes The Intelligent Investor for The Wall Street Journal, shared some tips for overcoming your brain's worst impulses. In part two of that interview, he shares some wisdom for making good decisions during times of financial crisis.

Let's think back to October or November of last year or March of this year, when the Dow seemed to be headed toward 6,000, and people were just terrified. There's no doubt that millions of investors, both retail and professional alike, were acting out of sheer uncontrolled fear. And the level of stress that investors felt was unbelievable. And when people are afraid, and when you're feeling stress, not stress in the pop psychology sense but stress in the physiological sense, when your blood pressure goes up, you're sweating, your heart is racing, your hands are shaking, you can't sleep, and you're on the verge of depression, and you're snapping at your family and kicking your dog, people make bad decisions. And they make impulsive decisions, they make big decisions when they should be making small ones. Instead of making incremental adjustments to portfolios, instead of rebalancing at the margin, people bailed out of asset classes entirely or just moved completely into cash. The other thing that neuroeconomics suggests goes on in people's minds in a time of market panic is the automatic perception of illusory patterns--detecting "trends" in random data that simply are not there. Things that seem to be predictable loom much more important in people's minds. People develop a belief that the future is more knowable. That's stronger in a time of extreme uncertainty.

So what was I seeing in my e-mails were hundreds of messages from people about how the world was coming to an end, quite literally. "We're going into another Great Depression." "The financial markets will cease to function completely." "I'm stocking up on granola bars and bottled water and extra cartridges for my gun." I got any number of "I'm going off the grid" e-mails. And the thing that's surprising to me is not that all of that happened, because that's exactly the sort of thing I would have predicted. What has surprised me is how quickly the mindset has shifted. And now it seems that people have completely forgotten how they felt a few months ago. And that's very troubling to me. It suggests to me that we're nowhere near out of the woods. I do not tend to make market forecasts of any kind, but that worries me so much that I think we're probably in for another big surprise before we have a full recovery.