UK investors pull out of equities – but should they be fearful?

11th January 2012

This isn't surprising, given the ongoing negative news flow. Investors continue to opt for ‘safe havens', such as corporate bonds or balanced funds, which invest in a mixture of shares, bonds and cash.

Investors have put themselves firmly in ‘risk-off' mode, reports This is Money, as they fear of a repeat of the heavy losses of 2008.

So, are you one of those wondering, what if my capital is in a sinking ship on turbulent seas? Can I stomach the losses?

Mindful Money asks – What level of fear should investors cultivate when making decisions?

There are various methods of measuring fear. For example, independent financial adviser (IFA) Hargreaves Lansdown produces an Investors' Confidence survey, which gives a good indication of how positive or otherwise its clients are feeling.

According to the most recent survey, the confidence index is about the same level as Feb 2009 – early in the last recession. The survey shows there is more confidence in investing in emerging markets and Asia Pacific than the UK over the next 12 months.

 "What is interesting is that the lowest confidence points are around the time of the lowest market levels, which often provide the best opportunities and returns for investors," says Danny Cox from Hargreaves Lansdown. For example, the FTSE 100 has risen by 45% since Feb 2009.

There is little doubt that market turmoil and volatility have a strong effect on the psyche of investors, and decision-making becomes dominated by emotional responses, rather than reasoned thinking, leading to – for example – selling stock at precisely the wrong time.

How else do we measure market fear?

The "Fear Index", as the Chicago Board Options Exchange Volatility Index (VIX) is often known, is the subject of the Robert Harris thriller, The Fear Index, and tends to rise when stocks fall. The index measures the cost of options that are bought to insure against equity losses, with a high level indicating how worried investors are about more share price falls. Here, blog Seeking Alpha comments on 2011 as the Vix ‘year in volatility'.

The blog says: "In a year where most asset classes struggled mightily, volatility was one of the few great long positions. With a higher starting point going into 2012, it will be difficult for the VIX to repeat its market-beating performance once again, but if the euro zone and some of the geopolitical flash points fail to make progress, 2012 may indeed be the year of the VIX."

Danny Cox says: "The ongoing Eurozone saga continues to cast a dark cloud over stock markets and it is difficult to see how progress can be made until these problems have a more permanent solution. One of the problems with this financial crisis is the investor has few alternatives to markets, with cash paying very little and property in the doldrums. "

What is the key to managing our anxiety?

Shaun Richards, Mindful Money's economist blogger, says: "If you're a professional investor you need to keep calm, as the next crisis will be along soon. In essence your intellect and emotions provide a guide, and will be in opposition to each other. So when your intellect tells you the time is right but it feels emotionally wrong and you feel sick and fearful, it is the time to buy – and the reverse is also true, so when there is bombast and euphoria it is often the time to get out. Of course, this isn't the case all the time, but it is a general guide."

Amid the doom and gloom there are always positive equity stories. Let's go back to 2009. Then, the FTSE 100 was as low as 3500, and a plethora of companies in the FTSE 350 were undervalued based on earnings and net asset value, showing all the characteristics of being wise investments – strong cash flow and potential for future growth. However many investors were paralysed by fear because they had seen the stock market collapse from highs of 6700 just 18 months earlier and were unsure of how low the market would fall – so they failed to take opportunities.

Kim Stephenson, Mindful Money's psychologist blogger, says: "The saying that the market is run on greed or fear is true. Ideally, people don't take any notice of the news and don't react to the greed or fear running the market at that time – like Warren Buffet, you invest for the long term and ignore the "hot tips", trends, daily (or hourly, or real-time) updates, etc.  So you don't react with greed or fear, you work out a strategy and follow it for the long-term.  But it takes a strong person to do that.  Most people convince themselves that diving in and out of the market is the best way.  All the evidence says it is the worst way (you lose more in dealing costs, if you miss the big falls you also miss the big rises etc.) but people still think that they are, like Mourinho, "the chosen one".  They aren't, and it will cost them, but human beings don't like that fact."

Finally, let's leave the wise last word to Warren Buffett – "Be fearful when others are greedy. Be greedy when others are fearful."


More from Mindful Money:

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