Given that investors’ emotions move in cycles from fear to greed and back again, two obvious questions to ask are “Where are we in the cycle now?” and, as greedy asset gatherers, “How can I make money from it?”

Entire books have been written about slumps and bubbles.

For this post we’re going to make do with a few over-simplified graphics.

Investor’s emotions in graphic form

Note that in the different attempts at visualizing investors’ emotions that I’ve collected below, you won’t find any shots from charting tools or similar

While I’ve no doubt that investors’ emotions do cycle, I’m very doubtful that many people can take short-term advantage of it through charts. So no double-tops, candlesticks, death crosses or any such technical analysis bric-a-brac here.

Rather, the main benefit to understanding emotions and investing is to know yourself better.

Once you appreciate how psychology moves the markets – and can influence yourself – it should help you stick to your plan, whether it be sensible passive investing or more hands-on active investing antics.

Greedy buying, fearful selling

Nobody is immune to the cycle of fear and greed. Even the greatest investor can get carried away, or else be made miserable by a deep market downturn.

From euphoria to despair

When I wrote that I thought the markets were a clear buy in March 2009 for anyone who was ever going to buy shares, I got nasty comments across the blogosphere.

I don’t mean “yeah, perhaps, but I don’t think he’s right”. I mean suggestions I was part of some secret narco-government backed plan to ramp up the market to make the last few people with any cash insolvent.

The nicer ones just said I was an idiot.

That’s what the bottom of a bear market looks like. (While I was confident it was a buying opportunity, I won’t pretend to have known the subsequent rally would come so swiftly!)

Nobody rings a bell at the top

This is the same graph as above, really, but I like how the creator has put in the shaded areas. This stresses that there’s a phase of euphoria and of despair, rather than a single event that marks the top or bottom.

For instance, where are we as I write in June 2019?

It’s complicated!

In terms of the US shares that make up the largest part of the assets of a global tracker, I’d guess we’re somewhere between exhilaration and euphoria.

That’s hardly the case for the Brexit-blighted UK market though. With domestic-facing stocks especially, it feels like we’ve been trudging through the denial to capitulation stage for at least three years.

As for the rest of the world – ex-US – I’m torn between thinking we’re sitting on an upswing at the optimism point, or sliding down the other side of the graph into pessimism!

The following graph is illustrative. It shows the divergence between the valuation of US shares and the rest of the world:

Source: Morgan Stanley

In other words, the US stock market looks very expensive compared to the rest of the world but – like the similar divergence between growth and value shares – this relative costliness has been the case for years now.

Timing a reversal is hugely difficult. Most investors will do better to stick to a passive investing plan.

Blast from the past: In the 2010 version of this article, which I’m updating in 2019, I judged global markets sat somewhere between hope and relief. I wrote: “If I’m right, then the masses who are still waiting for an optimistic mood before buying will pay a steep price in forgone returns.” History has shown that was true, demonstrating at least the potential for making a ‘precisely wrong but roughly right’ long-term forecast. (Or, alternatively, proving one can get lucky now and then!)

It’s less risky to buy something unwanted

Most active investors, for their sins, need to pay attention to sentiment – otherwise they’ve no business active investing.

It’s usual better in the long run to buy an asset nobody currently wants, mainly because you might get it cheap.

If it’s cheap then there’s less far for it to fall, as well as much higher for it to climb.

Also there’s probably not much optimism ‘baked into’ the price. That means there’s potential for something unexpectedly good to happen, which could lead to a reappraisal of the asset’s value.

In contrast, buy something everyone loves when everyone is buying, and if it disappoints you face the double-whammy of a de-rating.

Elementary, you’d think, but for some reason people like to buy expensive. Just ask my friends, who almost to a man1 shunned my suggestions to invest for the long-term in the 2008/2009 bear market.

As investing veteran Howard Marks writes in Mastering the Market Cycle:

“Superior investors are people who have a better sense for what tickets are in the bowl, and thus for whether it’s worth participating in the lottery.

In other words, while superior investors — like everyone else — don’t know exactly what the future holds, they do have an above-average understanding of future tendencies.”

Nothing new under the sun

This is clearly just the chart above, jazzed up for a fund manager’s literature.

What’s interesting though is the date. This chart was created in 1998. Just two years later we saw the mother of all stock market bubbles, and nine years later one of its fastest and most frightening slumps.

If you’d seen this chart 12 years ago, wouldn’t you have been better placed to ride through that roller coaster?

Little ups and downs add up

I like this graphic because it includes lots of jagged lines. The other charts make riding investors’ emotions look as simple as going up and down on a see-saw, but in reality it’s a lot tougher than it looks.

Is any particular zig the start of a new leg-up – or is it the last gasp before a zag down into a slump?

Very hard to tell until five years later.

Funny old investors, and their emotions

I’m pretty sure I first saw this graph during the dotcom boom. It’s been regularly wheeled out ever since.

No wonder: Whoever knocked it up all those years ago knew everything you need to know about investors’ emotions, and had clearly been around the block.

I wouldn’t be surprised if he or she had said these things to themselves. Books and blogs are reasonable teachers, but nothing beats living through a cycle of fear and greed to really appreciate sentiment and emotion in the market. And to get a sense of your own risk tolerance, of course.

Further reading:

• How to spot a bear market bottom
• How to spot a bull market top

1. The women were genuinely smarter, and kept dripping money in [↩]

What caught my eye this week.

I went to a chilling talk this week by Oliver Burroughs, the author of Moneyland. The book is a tourist’s guide to that murky realm where offshore finance and spurious shell companies meet kleptocracy and tax-dodging Belgium dentists.

When did you last change your mind about something big? We all know it’s rare.

Well, I went into that talk thinking that super-rich tax avoidance was in large part a handy bogeyman for politicians to trot out, and that onerous anti-money laundering procedures were quite possibly an overreaction to several miserable developments of recent years, such as terrorism and the ill-judged War against it.

And I came out temporarily terrified.

Of course I want rich people to pay their taxes like anyone else.

I’m also against the looting of poor nations – who wouldn’t be, bar the looters?

But the big picture Burroughs paints is of a world where wealth everywhere is inexorably moving out of reach of the State and the tax man. This has already crippled the budgets of developing nations and it could eventually threaten our own.

From his award-winning book, which is just out in paperback:

“…this means Moneyland has neutered the core functions of democracy – taxing citizens, and using the proceeds for the common good – which in turn has disillusioned many people with the democratic experiment altogether.

In despair they have turned to strong men … who have further undermined democracy in a vicious cycle that benefits no one but the rich and powerful.”

Burroughs is right that this has crept up on us. For example, we’ve all read stories about the dubious money behind London’s luxury high-rise boom – and then turned the page to the sports section.

Perhaps some of you will call me naive in the comments and point out other such stories. But what impressed me from the talk wasn’t the existence of these dubious channels but the sheer scale – 10% of global GDP and rising.

Who watches the Watchmen?

By coincidence, the day after the talk I heard Paul Lewis bemoaning the high cost of financial regulation in an FT podcast. Lewis estimates it costs £1.7bn in the UK, and rightly points out that it’s ultimately paid for by us honest consumers.

In the FT‘s printed version, he notes [Search result]:

“…the good guys will continue to pay compensation for the bad guys. And everyone who uses financial services — just about all of us — will continue to stump up for the nearly £2bn a year we spend enforcing the rules, fining those who break them, and compensating those who have been cheated.

The most expensive lawful industry in the world. Probably.”

Lewis is no cheerleader for a trodden-down financial services industry. His inference is that the sector should be doing more to police itself.

Just be honest, guys!

Well maybe. But if we can’t get a grip on the off-shoring of not just money but accountability – and even in one case Burroughs highlighted, legal vulnerability, shielded against by paid-for diplomatic status – then those billions spent each year will seem trivial.

Especially compared to the price we may ultimately pay.

[continue reading…]

The following guest post is by Mark Meldon – our favourite independent financial advisor (in an admittedly narrow field!) Now and then we persuade Mark to explain some of the more obscure or technical corners of personal finance.

I believe it’s worth us returning to the topic of life assurance – one of the essential matters that Monevator readers need to consider on a regular basis.

There seems to be some mass incoherence amongst the general population when it comes to confronting our mortality.

People – willfully or otherwise – forget that we all dangle by a very thin thread.

The result is that taking out insurance to protect dependants by creating a tax-free pool of money to replace lost income is an option simply ignored by millions of us.

Many independent financial advisors (IFAs) don’t bother with insurance either, as they say it isn’t profitable.

That’s crazy – and irresponsible – in my view.

All of your sexy investment and pension plans can soon turn to dust should disaster strike. For the sake of paying very modest premiums – for something I sincerely hope you never need to use – you can cover off that risk.

You hope they don’t pay

On a more positive note, there is plenty of money going out to beneficiaries who’d surely back up what I’m saying.

In 2017, Aviva paid out £525m in death claims, Legal & General £636m, Royal London £517m and Zurich Assurance £235m. AEGON recently stated it paid out £67m in 2018.

These companies are some of the largest providers of life cover in the UK, but others are available in what is a fiercely competitive market.

It’s also interesting to note that policies arranged through an intermediary such as an IFA tend to have a much larger sums assured. I’d hope this is because careful thought has gone into the amount required by a given individual, as opposed to a scattergun approach.

I am, however, concerned that something like 85% of life insurance policies arranged each year are not set up properly at outset. This can cause severe difficulties in many circumstances.

It is all to do with ‘writing’ the policy into a trust. The recent deferral by the government of proposed big increases in probate fees set me thinking more about this.

The suggestion of an increased liability for IFAs like me for failing to take reasonable steps to ensure that life policies are protected from probate is of serious concern to me, my family – and my professional indemnity insurers.

Let’s hope that the ambulance chasers don’t get involved.

Unmarried couples beware!

Mind you, with average life policy sums insured still far below £200,000, inheritance tax is unlikely to be a big problem for most people.

But something else really could be.

Let us say that you took out a life policy with a sum assured of £250,000 because you have just become a parent. Imagine your partner did exactly the same.

Sensible. You bought the policy with every good intention, either online or, perhaps, through an IFA. You’ve been paying your premiums ever since.

Job done!

Or is it?

Like many couples nowadays let’s say you’re not married but rather cohabit a house with your growing family. Sadly, you then die.

How would you feel if, on your deathbed, you realised that your soon-to-be-bereaved partner for whom the life cover was intended stood to get nothing at all – a 100% loss, of typically around £150,000?

This doesn’t happen because your policy provider declined the claim. Rather it happens because your policy wasn’t set up properly.

Well I’m afraid that this is what can easily happen to unmarried couples, because the sum insured would fall back into your estate and be subject to your will or the laws of intestacy.

It could then end up in the hands of the wrong people who might – just might – refuse to hand the money over to the person you intended it for.

Yikes!

Use a trust

Until a few years ago this was a very small problem. Most life policies arranged by new parents – or those with joint liabilities such as mortgage payments or the rent – were joint life policies.

These joint life policies paid out to the survivor after the first death.

Besides, even if a single life policy had been arranged most couples back then would have been married and the laws of intestacy – or their will, assuming that had one – would have likely saved the day.

So much for yesterday – what about today?

Anecdotally, something like 70% of life policies arranged nowadays are arranged on a single life basis. There may be good reasons for this. But it presents a big problem for the growing number of unmarried couples who just don’t understand how important it is to set their policies up correctly.

The solution is to write the policy into a trust AND make sure that there is at least one trustee – hopefully the partner for whom you bought the policy in the first place.

Prepare properly for the unthinkable

The proportion of couples that are unmarried continues to increase. The highest share is among the age groups who already have small children, and who are first-time buyers or renters.

According to the Office for National Statistics, nearly 40% of unmarried couples have a male partner aged 30-34. Some 70% of children are born with a father aged between 25-39.

Yet research from Unbiased found in 2017 that 72% of 35-54-year olds don’t have a will!

Even if you have a will – and you really must – don’t forget that it can be challenged. And it still has to go through probate and, perhaps, inheritance tax calculations.

According to the recent British Social Attitudes Survey, approximately 50% of couples wrongly believe that there is such a thing as a common law marriage. There is no such thing!

Hence, I find it almost unbelievable that only around 7% of life policies are set up wrapped in a trust when, in truth, nearly all should be.

Case study: Second time around

It is quite common, nowadays, for relationships to be very different from our grandparents’ time because of marriage or cohabiting breakdowns, and these often involve children.

Indeed I have just been dealing with a situation where simple life insurance has been employed to solve a tricky problem as a new relationship beds down.

It is all about ‘financial input’ – cold-blooded as that phrase is – and unforeseen consequences.

One of my clients, let’s call him John, is a lovely chap. Sadly, John’s first wife died ten years ago at a young age, leaving him with two small children to raise on his own. His late wife carried substantial life insurance, and there were generous pension benefits, too. John has raised a fine pair of young adults who, I’m sure, will go on to lead successful lives.

Time is a great healer. John is now closely involved with Jane and, I’m pleased to say they intend to marry next year.

Jane is divorced and has two younger children from her previous relationship. Because of their ages, there won’t be any new children. They each own houses – Jane’s with a mortgage – and they would now like to purchase a property together and set up a new family home.

Very fortunately, they are looking at properties around the £1m mark, as the life insurance that paid out 10 years ago has been invested and produced good returns.

Of this £1m budget, the input from John will be about £800,000, and from Jane £200,000. Quite understandably, they both wish to ensure that their own children receive their ‘due’ when they die, so they are arranging with their excellent solicitor to purchase the new property as tenants in common, with John initially owning 80% of the new home, and Jane 20%.

So far, so good.

However if one or the other of this couple should have the bad timing to die sooner rather than later, it creates a problem for the survivor as far as paying the kids’ inheritances are concerned.

Jane has not got £800,000 available to buy out John’s children’s financial ‘expectations’ and, although John would be able to dip into his funds to cover those of Jane’s children, he would prefer to avoid having to do so, as the money should pass to his own children.

I therefore suggested that John purchase £800,000 of life cover to age 70 (by which time they might be thinking of downsizing and so on) and Jane £200,000 on a similar basis.

These policies have been set up with John’s children as the ‘named beneficiaries’ on his policy and Jane’s children on hers. The insurance will be in a ‘flexible trust’ from the outset, with each other being appointed as trustees. We have also appointed another independent trustee who can act as ‘overseer’ should a claim unfortunately arise.

If John dies whilst the policy is in force, the £800,000 would be paid out, tax-free, to his trustees (Jane and the referee trustee), thus giving Jane the funds to ‘buy-out’ John’s children’s interests in the property. This would allow Jane the luxury of not having to sell the home to raise the funds to do so.

My couple felt that the monthly premiums of under £150 were a price worth paying for peace of mind, covering off something that they were both concerned about.

Avoiding problems with trusts

Not writing a life insurance policy in trust is pretty daft, I have to say, and that goes for new and existing policies.

I hope I have explained why, for the sake of a bit of thought, you really need to do this.

Happily, this problem is simple to avoid or deal with. Several of the insurers I mentioned earlier have put great effort into getting it done right at outset, with superb online trust documents. Even the ones still using paper-based documents have excellent trust wordings available free of charge.

My suggestion? Check your policies, set up a trust for your loved ones, and write a will. And if any of this seems difficult, ask an experienced and qualified IFA for help.

Mark Meldon is an Independent Financial Advisor based in Cheddar, Somerset. If you need an IFA closer to home, try the directory at Unbiased. You can also read Mark’s other articles on Monevator.