Emotion Free Investing Is the Key

Posted on December 6, 2012 at 11:25 AM PDT by

Want emotion free investing? Consider first a mental experiment: Picture yourself trying to cross a road. It’s a two-lane city street with a clearly marked crosswalk and traffic lights. It’s broad daylight, traffic is light.

Naturally, you wait for the signal to change. You look both ways and cross, confident you will arrive on the other side safely and securely. If you’re relatively young and healthy, this is easy. Your vision is sharp, you hear cars coming and going, turning the corners and otherwise following the rules. All is well.

It gets harder, of course, if conditions change. It might be dark, raining, or both. Maybe the roads are not clearly marked. Perhaps there are stop signs but no lights and no crosswalk.

Suddenly, you are thinking a bit harder about your choice of clothing. That dark jacket and pants now feel like a mistake. Is that oncoming pickup truck really going to stop? Can the cars in the other turn lane see you walking?

Crossing a busy street is, in our view, an apt metaphor for retirement investing. If the rules are clear and expectations reasonable, most people can do it without fear of getting run down by a passing truck.

Yet emotion free investing is difficult. Our markets are far from clear and reasonable, as several highly placed people took the trouble to point out in recent days.

The first is Amy Butte, the former chief financial officer of the New York Stock Exchange. In an Op-Ed for Bloomberg News, she went to great pains to make a clear-eyed case that our financial markets are being hijacked by high-frequency traders. She specifically nails the Securities and Exchange Commission (SEC) for letting it happen.

The markets simply don’t work anymore, she writes. High-frequency trading now makes up half of the volume, while an explosion of order types does little more than guarantee confusion for ordinary investors, increasing stress and making emotion free investing impossible.

Butte continues:

By allowing markets to descend into a mire of complexity, the SEC has abdicated its core values and mandate, which is ‘to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation,’ according to the mission statement on the agency’s website.

When only firms with the most advanced technology have an advantage, the markets aren’t fair. When market participants can no longer understand order types, the markets aren’t orderly. When there is no cost to using capacity without making actual trades, as high-frequency firms do, the markets aren’t efficient.

Remember, this is the former CFO of the New York Stock Exchange. If she sees problems, you can be sure they’re not exaggerated.

A similar sentiment is found in a recent study from the U.S. Commodity Futures Trading Commission (CFTC). Their chief economist, Andrei Kirilenko, maintains that high-frequency traders are profiting at the expense of smaller traders.

The details come from a report in The New York Times, which couches the news by explaining that the paper has not yet gone through peer review, an academic process by which new research is first vetted by others in the field.

Nevertheless, one of the CFTC’s comissioners, Bart Chilton, described high-frequency traders as “the new middleman in exchange trading, and they’re taking some of the cream off the top,” according to the newspaper.

Reading these two items back-to-back might prompt you to give up on emotion free investing and bury your cash in the backyard. That’s clearly no way to retire.

Worse, our collective recent experience with the credit crisis and the ensuing recession seemed to teach that investing is by its nature a high-risk endeavor, akin to closing your eyes and stepping off the curb at rush hour. In short, that emotion free investing is unrealistic.

Emotion-free investing made easy

It doesn’t need to be this crazy, for sure. If history is any guide, though, the powers that be will stand back and let things ride until there is some kind of embarrassing implosion, another Flash Crash or otherwise “unexplainable” mini-meltdown.

Yet you should invest and stay invested, despite the turbulence and the risk involved. They key to emotion free investing is to be ready to manage that risk by owning a variety of assets as part of a carefully designed portfolio, one that includes stocks, fixed income, commodities, foreign equities and real estate.

Disciplined rebalancing works, taking the emotion and fear out of the equation, helping investors to buy low and sell high with emotion free investing like clockwork.

You can’t change the realities of the marketplace any more than you can halt traffic by waving your hand. But you can improve your outcomes with some simple, commonsense precautions that promote emotion free investing.

It is possible to head across that street toward retirement with your eyes open, alert and confident of getting to your goal, safe and sound and with your retirement portfolio in one piece. And that’s the answer of emotion free investing: To get to the other side.