The past 17 months have been a humbling experience for most investors. Paper losses, according to some estimates, have exceeded $4.2 trillion dollars, and the record ten-year economic expansion is threatened with recession. The Nasdaq plummeted nearly 65% from its high and many technology stocks have retreated 80%- 90% from their 2000 highs. Because of the speed and intensity of monetary loss, the current financial devastation is comparable to the crash of 1929—although we expect the recovery to be swifter and more rewarding.  In this context I’ve received many calls from journalists wanting to know—beyond monetary loss--what all this means for our collective psychological state. So it seemed appropriate to try to put into words what I’ve learned through many conversations with distraught investors over the past year.

The Investor’s Relationship with Mr. Market 

Assuming we’ve done our research, before committing money to a stock we delve into a company’s management, products and services, financials, technical trading patterns, and analyst reports. For many investors the results of this research produce “objective” data that help determine buy/sell decisions. What’s often forgotten is that every investment in the market is also accompanied by fantasies (conscious or unconscious) that embody our deepest experiences of being in the world. Some of these fantasies relate to the ostensibly objective data we’ve collected. For example, we may believe that some new technology will change the way our culture does business; we may believe that a CEO is the smartest manager we’ve ever met, someone capable of leading his or her company to tremendous market share in its industry; we may believe that, as a result of our financial analysis, we’ve brilliantly discovered an undervalued investment that the world has yet to hear about.

Other fantasies relate to how we use the market to sustain our sense of self (our self esteem, confidence, vitality, security, initiative, and wholeness). Years of psychological research have proven that just as we all need oxygen to sustain our physical selves, we are “hard wired” to need and seek out attachments and experiences that provide the psychological ingredients that maintain and fosters the growth of our sense of self. In most instances these attachments involve relationships with other people, but it is also clear that the non- human environment—institutions, ideas, books, nature, music—can serve the same function. Think, for example, of how a walk in the woods or listening to music can provide calmness and soothing when we are upset, or how being associated with a well-known institution can make us feel more confident and important. Guess what? Investing in the stock market is often used to provide those same psychological ingredients we need for growth. 

Think of the times you buy a stock and it immediately appreciates in value. Even if the increase in stock price has nothing to do with the reasons you bought the stock, you feel smart and competent. Everyone who invested in the dot.coms previous to March 2000 felt like a brilliant investor—someone to be admired and applauded for his or her stock picking savvy.  Those who believed in Henry Blodgett or Mary Meeker and were guided by their analysis of some of the Internet Stocks felt bolstered and uplifted by the imagined connection with these gurus. Concretely, the feeling was “you’re great, you understand these new economy stocks, and I follow you, so I’m great too.”  Those investors who decided fundamental analysis was passé and joined together to trade stocks according to candlesticks, oscillators, resistance and support levels, and other complex technical formulas felt like kindred spirits in step with each other, enhanced because they shared the same philosophical approach to investing.  What is important here is that the process of investing has the potential to perform a psychological (internal) function that helps to sustain, expand, and enhance our sense of self. These functions are different for everyone because they are subjectively perceived rather than being real. Mr. Market could care less whether your stock goes up or down. It is the fantasies you create around your own investing decisions that serve as the sustaining functions. 

Your Sense of Self in a Down Market

When the market crashes, turns bearish, or severely corrects, we not only lose objective things such as money. We also lose the sustaining functions of which the investing process (and or money, which may psychologically represent self esteem, independence, power, etc.) has been the source. That means, in addition to objectively not having the money to buy that new house or car, our self-esteem drops, our capacity to calm ourselves down is diminished, our motivation wanes, our confidence is shaken, and our vitality ebbs. I am reminded here of the patient who, when asked about his complaints, tells his internist, “My stomach, hurts, my head aches, my body feels cold, and you know, doc, I don’t feel so well myself.”  A down market represents an injury to our total sense of self and all the functions that sustain it. In a general way it represents a hope or fantasy lost.

In response to this injury we institute emergency measures to compensate for the lost sustaining functions.  For example, where we feel anxious and lose the capacity to calm ourselves down, we might frantically seek out others to serve that function. We repeatedly call brokers, company management, other investors, or pursue scattered rumors on stock message boards. We may turn to books or articles for reassurance. During bear markets, for example, sales of Graham and Dodd’s Security Analysis typically go up significantly. It becomes much easier to understand why some investors believe rumors on a stock message board if we understand the self-sustaining functions being served by seeking out information there.

If the bear market causes us to lose a self-image that was affirming, e.g. “I am a smart investor,” then we may lose the capacity to feel good about ourselves.  Our vitality may ebb and we feel depleted and empty. To compensate we may seek out stimulating activities to overcome the deadness that has set in. We might trade too often in an attempt to make up for losses, some may use drugs or alcohol as a stimulant, others may engage in dangerous, high-risk activities. Still others use sexual activities as a stimulant. But no matter what the idiosyncratic response, the important thing to remember is that our behavior in the wake of a down market is less determined by the external loss and more determined by its impact on our self-experience.
Depending on the strength of our sense of self, down markets will affect us differently. Think for example of two people whose boss criticizes them at work. One is able to allow the criticism to bounce off her with the realization that the boss is having a bad day; the other allows the criticism to eat away at her for the whole day, feeling immobilized and unable to accomplish any meaningful work. How solidly we have internalized our self- sustaining functions will determine our reactions. When less has been internalized, we will need more external compensation. 

It is in our attempts to compensate for the loss of self-sustaining functions that most investing mistakes occur. That’s why well-known investors like Barton Biggs have commented  “…the mature, diligent, intelligent investment manger enhances his potential for better investment performance only through greater self-understanding.” Too many times in down markets we try to solve our dilemmas by solving the wrong problem because we address it on a behavioral (external) level rather than a psychological (internal) one. To solve investing problems we need to address them by understanding the subjective experience of the investor. Consider the following example.

John repeatedly bought stocks that were recommended to him by some well-known money managers that he knew. In each case after he invested, the stock plummeted (which may have been more of a market phenomenon than a fundamental problem with the companies). But John was consulting me because he wondered why he kept making the same mistake over and over again. He knew that he shouldn’t invest on rumor and that he shouldn’t buy on some one’s recommendation without doing his own research. But the pattern continued despite this knowledge. 

Dealing with rules such as don’t buy on tips and rumors, or don’t buy unless you research a stock yourself is approaching the problem on a behavioral level. It doesn’t address John’s subjective experience in buying these stocks. When I asked John what came to his mind when he thought about buying his friend’s recommendations, he replied, “These guys are pros, they know what they’re doing, and they don’t go around telling everyone what they’re buying.”  So it quickly became clear that John experienced these tips to mean the money managers’ felt he was special. John was having difficulty regulating his self esteem as an investor in the absence of others thinking he was a unique and special person. When he bought their recommendations, he was enhancing his self-esteem at the cost of losing money. Unconsciously the importance of the self-sustaining function being offered by these “special” recommendations was more important than whether the recommendation was a money making one. In an up market, these stocks probably would have been appreciating in value and John would have felt both special and like a brilliant investor. In a down market, however, it becomes extremely important to understand how psychology affects investment decision-making because the addiction like pursuit of self-enhancing functions becomes decoupled from sound investing. 

Getting Back on Track

Great investing cannot occur in the absence of our understanding the nature of company fundamentals, management, products, services, and technical patterns, as well as the historical and contemporary context of the economic environment.  But all of this becomes meaningless unless we can use self-understanding to keep emotions from ravaging our actual investment decisions. The only way to accomplish this is to shift our attention from the behavioral level to understanding how we subjectively experience our selves.  Ask yourself the following questions to help with the self-analysis.

1) What comes to my mind when the market is going against me?

Here we are looking for the impact of the external situation (the down market) on our self experience and the accompanying self-sustaining functions. In other words, what is the internal loss? Are we losing our ability to regulate our self-esteem in the absence of the market’s confirming validation? (e.g. I feel stupid, how did I make so many mistakes, I knew I should have sold earlier”). Are we losing our internal belief in a looked up to other? (e.g. “I knew I shouldn’t have trusted that analyst’). Are we losing a role that was affirming? (“I can no longer be a good provider for my family”).  Knowing what self- sustaining function is being affected leads to the next question.

2) What have I done in the past to restore myself when this has happened?

Here we are searching for similar feelings in the past in an attempt to discover strengths that may be available to right ourselves. For example, once John discovered that it was his needed attachment to others who thought he was special that led to repeatedly buying his stocks, he was able to think about other ways he was special—he was a good father, well respected at work, thought of as special by his clients. Once he allowed these other areas to become more recognized, he no longer needed his “gurus” to confirm his specialness. He realized that in the past when he felt unrecognized, he would think about his day at work and remind himself of some of the appreciative things his clients had said to him.

3) Despite my mistakes, what have I done right in this market?

Here we are searching for pockets of strength which can be used going forward. For example, Laura spent many months researching a company before she made a large investment in the stock. After waiting several years, the stock increased nearly 2000%, but she failed to sell before the market crashed around her, thus losing much of her gains. She became extremely self critical, which made her hesitant to make any investments. But when she focused on what she had done right in the market, she realized that she had done a superb job of researching and being correct about the company she invested in. The company performed exactly as she predicted it would. Even though she failed to sell at the correct time, the realization that she had performed superior research restored her confidence in making the next investment. In addition it allowed her to examine her mistake (she had allowed her sense of competence to become too grandiose and thus ignored warning signals from the market) so as not to make the same mistake again. 

4) What kind of cognitive planning can I do now?

Cognitive planning allows us to decenter from our emotions and put our intellectual capacities to work in the service of recovering from what has been a psychological injury. Rather than being frozen in a bear market or retreating to an “I don’t care anymore” mode until the market recovers, we can begin to examine ways to get back in the game. What should we be selling to be prepared for the next upturn? How much cash should be on hand for new buying? What industries will lead the next recovery? Which stocks in those industries should I be prepared to buy, and at what price?  What new choices do I have to play this down market that I haven’t thought about before?  Such personal questioning revives our lost confidence and generates new motivation to re-engage in the market.

By continually attempting to understand the personal ramifications of external market events, we can free up unknown strengths and put them to work in re-entering the market. 

© Richard Geist, August 2001