Psychology Today Blogs - Robert L. Leahy, Ph.D.

Third Week: Challenging Your Worried Thinking

Robert L. Leahy, Ph.D. — Mon, 13 Oct 2008 07:22:24 -0700

Well, I have to apologize to those of you who have been following the ANXIETY FILES on worry. I took a detour for the last couple of weeks to address your anxieties during this financial crisis. But if you followed my blogs on financial worries, then you have learned something about how to handle worry in general. This included challenging some of your negative worries about finance.

During the first two weeks of your Worry-Cure Program you learned how to examine the differences between productive and unproductive worry and you learned some techniques to deal with acceptance of uncertainty and limitations. In this third installment, we will look at some simple techniques to handle your negative thoughts.

Challenge your worried thinking

Many of your worries are based on overly negative and distorted thinking. You are fortune-telling (predicting the future based on limited information), you are only looking at the negative information and not considering that there are positives available, you are discounting your ability to cope and solve real problems, and you are thinking that what will happen is a catastrophe. In fact, in my recent blog on How to Handle a Financial Panic Attack I outlined some of these cognitive distortions that drive the current panic about Wall Street. Many more examples of how to handle your distorted negative thoughts can be found in my book The Worry Cure: Seven Steps to Stop Worry from Stopping You. (For those of you who are clinical psychologists, you can learn almost 100 techniques for handling negative thoughts from my book, Cognitive Therapy Techniques.)

Let's take a quick look at a few questions to ask yourself.

Am I jumping to conclusions? Only focusing on the negative? For example, in the current financial crisis, you may be predicting that you will lose all your money, the American economy will sink into a devastating depression and everyone will lose his or her job-including you. But aren't there positives out there? Even if you lost part of your stock portfolio, you still have most of it left. You probably still have your job. The governments of the G7 are doing an enormous amount to stabilize the situation. Many of the predictions that we make when we worry don't come true. The research actually shows that 85% of the things that worriers worry about have a positive or neutral outcome. This may be one more false alarm.

What is the evidence for and against my prediction? When you worry, you generally focus only on the negative. Write out a list of the evidence for and against your belief that the negative outcome will actually occur. For example, let's say that you have the thought, "I will lose my job". List the evidence that supports and refutes this thought. Weigh the evidence. What is the quality of the evidence? Are you basing your prediction on your emotions rather than the facts?

Even if this happened, how is it not a catastrophe? Bad things do happen, but they are seldom catastrophic. For example, let's say that you lost your job. Certainly that would be a negative outcome. But how would you still be able to cope? Don't most people who lose their jobs find new jobs? Have you ever known anyone who was unemployed for a period of time? How do they cope? Even if the negative thing actually happened, what would you still be able to do? For example, you worry about your finances right now. But what can you still do today and tomorrow even though you may have lost money?

What advice would I give a friend? We are often more objective and helpful with friends than we are with ourselves. How could you help a friend see things differently? Are you more reasonable in considering the problems that others have? Why is that? Do you have much more exacting and demanding standards for yourself? Why? What would happen if you were more compassionate with yourself?

How often have I been wrong in the past? As I indicated, 85% of the things that worriers predict will have a negative outcome, actually have a positive or neutral outcome. How many of your past negative predictions have proven false? For how long have you been consistently wrong about the future? And, maybe you are actually good at solving real problems. Research shows that 79% of the time worriers say that they handle real problems better than they thought they would. Maybe you are generating 85 problems that don't exist but you are able to solve the one problem that may actually occur.

To learn more about how to handle your worries see my book The Worry Cure: Seven Steps to Stop Worry from Stopping You.

How Optimism Got Us in Trouble in Financial Markets: Or Why Smart People do Stupid Things

Robert L. Leahy, Ph.D. — Mon, 06 Oct 2008 08:12:51 -0700

In a previous post- Taking the Blinders Off: Knowing What You Should Really Worry About-- I suggested that there are many things that we should worry about but that we don't seem to bother to worry about. These include risky habits such as smoking, drinking, overeating, spending too much, risky sex, and driving dangerously. People generally don't worry about these things-if we define worry as recurrent, unwanted negative thoughts about the future. The same processes that lead us to avoid everyday real risks have contributed to the development of an overly risky financial market and credit crisis. The financial crisis is due to building a house of cards and then acting like we are surprised when it collapses. There's a risk when there is too much optimism.

But what has led us to build a house of cards?

And, why was the house of cards built by highly intelligent people---many with MBAs? How can smart people be so stupid?

Memory Lane and a House of Cards

Let's take a short trip down memory lane to understand how things developed.

Congress, in its infinite wisdom, decided years ago (1999) it was politically advantageous to assure that people without sufficient means should be able to get mortgages with very little down-payment and at subprime interest rates. ‘'Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ‘'Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' Thanks for Fannie Mae advocates, lots of people who couldn't afford payments could incur substantial debt.

This was immensely popular with people who could now own their own homes---or, at least, think they actually owned their own homes. Let's say that they bought a house for $250,000 and put down $20,000---they still owed the bank $230,000. So, they actually didn't own the house -the bank had most of the claim on the house. But they lived in the house and hoped that the property values would go up. And they hoped that their incomes would go up to cover the ballooning adjustable rate mortgages. As long as everything went fine, everyone was happy. In fact, millions of people did quite well. For a while. Optimism ruled.

Many of these applicants for mortgages were known in the business as NINJAs. They had No Interest Loans and No Jobs. NINJAs. Like NINJAs they felt proud and invulnerable. That is, until their property values fell, their mortgage payments ballooned, and they realized they had no real equity in their homes. Until the sorry day that they had to foreclose.

Despite warnings over the last nine years---from intelligent people from both sides of the political spectrum--- subprimes, predatory lending, and other risky practices continued. Indeed, the very people that subprimes and low down-payment standards were aimed for were the biggest victims. This is why some members of Congress, representing working class people, eventually warned of "predatory lending practices". But by then the party was too big to stop. See NY Times article on how this all developed.

Is Everyone Happy?

But before the bottom fell out, there were a lot of happy people going to the bank ---and leaving the bank with a lot of money. The bank officer who sold the mortgage got points and got a raise. The borrower got a house to live in-one he could not afford-but he was optimistic anyway. The bank then passed the buck (the mortgage) to Washington Mutual---and the bank made money up front--- and lent that out. And Washington Mutual made a profit on the mortgages, as long as people were paying. They were smiling. Everyone got a quick fix. And the house of cards got bigger and bigger.

Everyone was happy. Washington Mutual and the geniuses on Wall Street divided up the mortgages as "property" to secure other instruments of investment-called mortgage backed securities (MBS--- and I would like to emphasize "BS"). More BS for your mortgage lenders and borrowers.

They were all passing the buck-until the rest of us ended up holding the bag.

These were sold in the general market and became leverage for other loans and investments that were sold. Some of your investments were in those securities and-- for a while-you and I were happy. The whole world was smiling. We sang in perfect harmony.

Investment banks and hedge funds used these and other instruments of investment as a basis to leverage other investments. If I have a thousand dollars then I can borrow ten thousand dollars. I feel rich. I feel good right now. And the market was going up. I am cheering. The party seems to go on forever.

Foreign investors didn't want to be left out of the American Dream. They jumped in. They also want to feel good. And, don't they deserve a piece of the action? Aren't they human, just like the rest of us? How can anyone believe the warnings about Fannie and Freddy when everyone is getting rich and the price of real estate keeps going up?

Example: a patient tells me that real estate is a safe investment. "It always goes up" There is no law of gravity. He is going to buy an apartment that stretches his budget-with a payment plan that he doesn't pay any principle for ten years. He hopes that his bonus will help him afford this and he feels absolutely certain that his apartment will increase in value. It's a sure thing.

Sure things are often bad bets.

Beware the dangers of optimism.

Optimistic Blinders

I believe that the same processes that underlie risky behavior also contributed to the buildup of a financial crisis. Let's look at how each one of these cognitive distortions contributed to the manic optimism on Wall Street and on Main Street.

1. You evaluate risk by relying on your emotion-If you don't feel anxious, it's not risky

Everyone was feeling good---immediately. The thing that's great about instant gratification is that it works immediately. You feel good right now. And everyone in the scheme was feeling good the minute they participated. How could anything be bad if we are feeling so great?
Here's how it worked.

The borrower felt good getting the house, the banker felt good selling the mortgage (and getting points), Washington Mutual felt good adding to its portfolio, Lehman Brothers felt good selling mortgage backed securities, and we felt good buying them. The politicians felt good because they could take credit for the economy. And, after all, why should they care if a few years later the homeowner loses his house? They got their money and moved on.

It was all emotional reasoning and instant gratification. No one was looking at the evidence and the logic. The evidence was that there were a lot of people who owed money that they might never repay. The mortgage backed securities were based on promises to keep-which would not be kept. And the logic was that this was a Ponzi Scheme.
First one in--- you are the smart one. But don't be the last one out.

2. You estimate risk by relying on unusual dramatic events-if you are not reading about it in the news, it's not risky

There were no unusual dramatic events-until recently. We weren't reading about a credit crisis on the front page-until a few weeks ago. Members of Congress were protecting their interests (until recently) by claiming that Fannie and Freddy were doing a wonderful job. No dramatic bad news---until the bad news was all we heard. There were drips and drabs of bad news-which were not credible to most people, because they kept churning out the money. Who wants to hear someone say, "You're making too much noise", when we are having a party? Leave me alone.

3. You ignore "baseline" information-the real "averages" and "odds"

The baseline information should have been--- how often do people pay back money if they can't afford to pay it back? Optimists would say, "Look, the economy is in great shape. Unemployment is 6 % (not historically that high), we had growth in GDP in the last quarter, and the stock market is still in relatively good shape." The realist would say, "Nice try. But your optimism is due to looking in the rear-view mirror. You are looking at the past. The future is going to be different. Here is why it will be different. You are holding a lot of debt from people who don't have the money to pay it back. And the investment banks are highly leveraged. You are killing the currency."

"But look!", the optimist responds in glee. "I have a lot of money in my 401K".
The gloomsayer says, "You do--for now".
Just wait.

4. You assume that because nothing bad has happened so far that you are safe.

"I've heard these warnings before. Nothing really bad has happened." This is like the happy Russian roulette player. He feels safer with each pull of the trigger. Nothing has happened so far, so I must be safe. Let's raise the bets. I'm feeling lucky.

The roulette player keeps increasing the bets with each click of the trigger. "I must be invincible", he confidently proclaims. "Yes, of course, it's a new economy. It's not the old fundamentals. Forget about that. We are living in a new age. We have new instruments of investment. We have derivatives, mortgage backed securities, swaps, and who knows what else.

Because of this we are safe. It's all so complicated-even I, with my fancy degrees, don't know what the hell I'm saying. Everything is hedged. You've bought insurance with these investments."

And, the optimist spins the barrel of the gun to test his luck.

5. You focus on what you think will happen the next time-"The next cigarette won't kill me".

The wonderful thing about leverage is that the more you have the richer you feel. You borrow against assets that become less valuable. You think, "I can buy that house that is just out of reach". You assume "There is a bigger sucker down the road".

There is. It's you.

6. You ignore "cumulative risk"-how risks build up over time.

As you take more and more risk in your investments and spending you ignore the fact that the entire market is getting riskier. What goes up eventually comes down--on your head. But, you said back then, "It can't be risky. Everyone is doing it, everyone is getting into the market. "After all", you say to yourself, "the price of real estate in South Florida has been rising." That was a couple of years ago. You and your excitable friends were getting closer to the edge of the cliff.

You thought you were climbing a mountain. Ooops.

7. You want to avoid thinking about things that are upsetting-so you avoid thinking of real problems-"I'd rather have a drink"

You don't want to hear about the market, about mortgage backed securities, about the dangers of subprime mortgages, about extending your debt on your credit card. Who wants to hear bad news? Not you. You're an optimist. You believe in the future. Get rich now while the getting is to be gotten. Do it now. Don't bother thinking about the risk. After all, haven't a lot of people made a lot of money already? Where were you? Oh, don't worry, it's not too late. You can take a loan at very low interest with almost nothing down. Here's the wonderful thing about it. You can also take a home equity loan right after you close on the house. Then you'll have even more money in your pocket. Oh, don't listen to those pessimists. They must be depressed. They should be taking medication. They always spoil the fun. Don't bother yourself with those depressing warnings. Don't you believe in yourself?

8. You do not want to experience the discomfort of making a change-"It's too hard".

Can you imagine the resistance that Paulson would have heard if he had come up with this plan a year ago? No one would have believed him. Nothing bad had happened. Real estate prices in New York were still rising. People were still making money. To make a change would have seemed too hard, too politically damaging, too Un-American. Who needs it? The party is still going on. Paulson would have looked too dour.

Ummm. He did give us some warnings in 2007, but no one wanted to hear it.

But now he has been heard. Loud and clear. Finally. Of course, he had to make us realize that the sky was falling. He had to shake us out of our optimism.

Paulson had to close the door after the cattle got out. The bull market was over. The bull..... was over.

9. You prefer to procrastinate about things that are not affecting you right now-"I'll wait until I'm ready".

A year ago no one was being affected. Nothing had hit the fan. Everyone felt rich and clean. Warnings about the coming crisis were out there, but no one was ready to make a change and few people thought it was needed. You can put off doing anything because no one was being affected right now. It was 2007. You can do something when you need to do it. Of course, by that time---today-- (September 2008), it would have a heavy price-tag. A lot of people would lose jobs, lose part of their life savings, there would be more blood under the bridge. But in 2007 the party continued, you could put off doing anything. After all, there is nothing like instant gratification to make you feel safe.

And, after all, if you worked on Wall Street and you were high up on the hog you could count on a golden parachute. And, in any case, you probably believed your own bull.

It's funny in life. Sometimes there's a group of people who continue talking to each other-and they get dumber every minute. They actually believe themselves.

Oh, by the way, here's 700 billion dollars. Don't spend it all in one place. Have a nice day.

How to Handle a Financial Panic Attack

Robert L. Leahy, Ph.D. — Fri, 03 Oct 2008 07:24:48 -0700

Like many of you I have been watching the financial news with great interest. But I have also found that my knowledge of Cognitive Therapy has been immensely helpful. It may be that our anxieties right now are being fed by selective biases in our thinking---biases shared by millions of us who are watching the news. How can we be more rational? How can we cure our financial panic attack?

Here are some cognitive distortions that I believe are driving financial anxieties:

1. Catastrophic Thinking

It's almost as if five minutes can't go by watching the news without hearing catastrophic statements- such as "catastrophe", "meltdown", etc. But is there a catastrophe and will there be one?

Some of these issues have been covered in my recent blogs on Psychologytoday.com.

Let me describe a few in particular.

What is a financial catastrophe? As of now the market (DJIA) has fallen about 20 % from its high in the past year. This is in contrast to the market dropping 89 % in the 1930s from its high and losing about 14.5 % per year for about six years during the 1930s until it mildly recovered (by about 2 % in 1941--primarily because of defense buildups). The unemployment rate today is about 6.3 % as opposed to 25 % during the 1930s. Furthermore, until the depression had taken quite a toll on people, there was no FDIC, no medicare or medicaid, no unemployment insurance, no social security, no net to catch people in. In addition, the per capita income was a small fraction of what it is today and very few people actually owned their own homes. People were falling from a low level of real wealth to begin with. So many people were destitute. This is very different from the 21 st century USA.

Some people believe it's a catastrophe to lose 20% in an overvalued stock portfolio, not recognizing that they still have 80% of what they had before.

Now some will claim, "we are heading toward a catastrophe". I have two thoughts about these predictions. One is that it is possibly true ---only if nothing is ever done.

Second, it is not true, because it is inconceivable that even Congress can't get it's act together. I find "nothing happens" in Congress to approach 0 as an asymptote. Close to impossible. Is there anyone willing to make that bet with me? Once liquidity is opened up in the market by the laws that are established and new actions are taken (mark to market, increased insurance, FDIC extensions), then people will be able to borrow and the economy will continue to function more effectively. This is a difficult time, but solvable problem.

2. Fortune Telling

Perhaps I am doing fortune telling, but I wonder what the evidence and rationale is that some people have for saying that we are headed toward a catastrophe. Especially if monetary policy and liquidity is restored, it is not likely that even a 700 billion dollar "investment" will lead to a catastrophe. In addition, even though many people predict a recession (as I do), what is remarkable about the American economy is how few recessions we have had in the last 25 years. And people survive recessions. A recession is two consecutive quarters of negative growth. That might mean that a business netting one million dollars might net $950,000. This is hardly hunger in the streets.

3. Discounting the Positive

This is rampant in how individuals and newspeople respond to the crisis we are facing (and which I feel confident will be resolved). One factor that is being discounted is that even mortgage backed securities are eventually worth something. These are being labeled by some pundits as "junk" and "garbage"---but they are backed by HOUSES! Imagine this. Imagine that you lose your house to a bank due to foreclosure. How much will the bank be able to sell the house for--- eventually? Is it greater than zero? It may not be 100 % but it is hardly garbage or junk. It may be marked down by 25%, but it still is worth 75%. So whoever owns the securities that are backed by the house can recover significant amounts. Once these houses clear the market, the market returns to fair values. (This also means that your house and mine loses value for now. But if you are not selling your house this year, take a nap)

Another way in which pundits are discounting the positive is that there is about 11.5 trillion dollars in investment accounts in the USA---not counting the value of real estate (where the average American has 45 % equity in his or her house) for a total net worth of 58 trillion dollars. This is significant. We are a very, very rich country. This should not be discounted in this time of financial panic attacks.

4. Labeling

Along with mislabeling mortgage backed securities as "junk", there is continual labeling by politicians on both sides of the other side. How this helps solve the problem is beyond me. It's like entering negotiations by screaming at the other side. It seldom helps. In contrast, viewing opponents in the process of negotiation as having different interests, tradeoffs, theories and voter constituents is far more helpful. This helps the process of giving in to get more for both.

5. Selective Filter

There is currently excessive focus on the investment banks that were highly leveraged (30 to 1) and the poor balance sheets of those trafficking in mortgage backed securities. But there is an enormous national and international economy that still can create and consume products--and, once liquidity is returned, will be able to move forward. Perhaps they will move forward with more caution, but this is not a nuclear holocaust. It is perhaps for this reason that larger banks like Citigroup, Barclays, and Bank of America--along with wise investors like Warren Buffet--- view this as a BUYING OPPORTUNITY.

6. Shortened Time Perspective

It's almost as if the last two weeks have become the future of mankind. What congress does in the next day becomes a predictor of the future of America. Someone who has a difficult time getting a home equity loan may believe that this will mean that they will never be able to get financing (even though they have excellent credit and good equity). There is the sense of urgency that if I don't know right now, then it is awful. In contrast, a more rational perspective is that if you don't know right now, you will probably know later. Banks don't make money unless they lend it. And they will lend it to people with good credit. If you don't get the loan for a few weeks, exactly what will happen? You will wait.

As many of you know, there is a field of economics called "behavioral finance". It is cognitive therapy applied to investors. These are the times that we can really help people (including ourselves) get a handle on reality. Examine the way that you (and pundits) are looking at the recent news. It's like a financial panic attack!

Financial Anxiety and the Luckiest Man

Robert L. Leahy, Ph.D. — Tue, 30 Sep 2008 06:48:29 -0700

You are watching your 401k shrink in value and you are wondering how you will be able to pay your bills when-and if---you retire. Everything in your life right now seems to hinge on the money that seems to be disappearing right before your eyes. What can you do?

Diversified Portfolios

I've noticed that many of my anxious patients over the years who worry about money often get tunnel vision. They focus on one set of their assets and think that their entire wealth is based on that asset.

But your assets may be far more diversified than that asset. For example, your 401 K may be one asset. But are there other assets? For example, your house is an asset. It may have declined in value, but there is likely some net value there. The average equity in America in your home is about 45% and about 1/3 of Americans own their homes outright. Whatever your current situation, think about the asset of your home as part of your portfolio. Also, any insurance policies that you have that may eventually have a cash value. These assets may vary in value over the near-term---they may decline in some cases---but as you diversify, expand your time horizon. Where will things be in five years?

Another asset that helps you diversify your position is your earning capacity. Let's say you make $70,000 per year. Over a ten year period, with raises and future investments and savings, this "asset" has significant value. In fact, to replace that $70,000 per year you would need about 1.4 million dollars to throw off enough interest to yield that amount at reasonable rates of return.

So, you may be diversified and not know it. If you're not, start planning on how you can diversify.

Life Portfolios

Another way of thinking of diversification is to think about "utility" in your life. After all, what good is money if you can't buy the things that you want? I think of this as your "Life Portfolio". For example, utilities in your life might be experiences that you value--- friendship, love, family, leisure, fun, spiritual experiences, community, kindness, and other "goods". You probably can see that none of these costs anything. If you don't have these "utilities" in your life portfolio, then go out and try to find them. They're there if you look. But if you only focus on money, you won't see them.

The old adage that money can't buy happiness is largely true. (I know you will respond, "Yes, the best things in life are free, but I notice that they're more expensive today") OK. Laugh at me, if you wish. But here's my challenge for anyone with money worries: Find something every single day of your life that is free --and do that. Make it the focus of your day early in the day.

Some time ago, one of my patients said that he was upset that he lost a lot of money. Knowing him and the kind of person he was I felt safe saying, "Let's put that up on the shelf for a little while and talk about something else". I said, "Let's imagine everything has been taken away. You have no mind, no senses, no family, no money, no job. Nothing. You can get one thing back at a time-and I won't tell you how many. Here's the catch. You have to convince me that you really appreciate them."

He looked at me in amazement. Where would he start?

I thought I would get him started. "Let's take your eyesight. Close your eyes. Imagine that you are blind-forever. You can only get your eyesight back if you can convince me that you appreciate what you will see."

He said he wanted to see his children and his wife. He then made a case that he appreciated each one. Even the bad times that they had. They had to struggle together. He learned something for the struggle. He recalled moments that he loved and appreciated. He was in tears.

I asked him to open his eyes. "You've had all of this already. You just didn't see it. You were thinking about the money".

It was all there.

His homework assignment was a choice that he could make each day. "You can either worry about the money or you can show your family that you appreciate them and love them".

The next week was much better. He felt like the luckiest man he knew.

Anxiety, Investing and Time Perspective

Robert L. Leahy, Ph.D. — Mon, 29 Sep 2008 12:22:03 -0700

If you are like a lot of investors who are anxious, you have become derailed in your thinking in recent weeks, feeling that the bottom might fall out. The recent news seems bad, then good, and then you wonder what can happen next. Anxious investors often focus on what has happened recently and then they over-generalize to the future. If you are like a lot of anxious investors, you think that current bad news means that the future will unravel. And you believe that this can happen very, very quickly.

But a major component in assessing risk is time-perspective. If you are focused on the short-term and you believe that this predicts the future, then your emotions go up and down with ticks in the market. You sit by the screen, watch your stocks, focus on changes of less than a point for a stock and have a financial panic attack. You are not alone. But that won't comfort you, because you think all of you are going over the cliff.

Take a look at the following graph of the past nine months for the Dow Jones Industrial Average:

Now take a look at the DJIA for the past 18 years.

You will notice a few things if you look carefully. The shorter time perspective for the DJIA (for 2008) looks down-in fact, it may feed your anxiety and depression. But the longer-term perspective offered in the graph for 1990-2008 looks quite promising. The second thing to notice is that the shorter term graph has 10,500 as the bottom and the longer-term graph has 2000 as the bottom.

One way of looking at risk in your anxious market is to think about time-horizon---how long you plan to stay in and, looking back, how long you've been in. The longer-term investor has done well.

Take a look at the graph from 1980 until September 19, 2008-and notice that the market was at about 750 in 1980 and it's at 11, 388 on September 19, 2008:

Before you have a financial panic attack you need to ask yourself when you will need to take your money out of your retirement accounts. If it's tomorrow, then you have reason to be concerned. If it is in five or ten years you might decide to go back to sleep and like Rip van Winkle wake up to a new day in the distant future.

Someone once asked Warren Buffett what was the ideal length of time to hold a stock. He replied, "Forever". I assume Warren wasn't holding Lehman Brothers stock.

The old "dollar cost averaging" approach---keep putting in the same amount of money on a regular basis over a long period of time--- may prove to be the best way to manage risk. Trying to time markets, guess at stocks, and get rich quick are often sure ways to lose money and incur trading costs.

So, what's the best way of getting rich? Of course, inherit a lot of money. But if that is not possible, the best way of getting rich is slowly---very slowly-over a long period of time. And to live within your means.

Nervous about the markets? Stretch the time horizon.

And, maybe there are bargains out there in the panic.

Anxious Financial Markets: How Fear Drives Investments

Robert L. Leahy, Ph.D. — Fri, 19 Sep 2008 08:41:27 -0700

All of us have been watching the gyrations of Wall Street and the stock market in recent days. With the collapse of Bear Stearns and Lehman, the "rescue" of the failing Fannie Mae-Freddie Mac, and the bail-out of AIG, many people wonder, "Have investors completely lost their minds?" Well, the answer may be, "Sometimes". Here's how we might look at anxious investing during a time of market volatility, uncertainty, bad news, and fear.

How does the anxious investor think? Let's consider two possible investors--- one who is reasonably optimistic and the other who is pessimistic.

Pessimistic and Optimistic Investors

Consider Jones who is considering an investment and who believes that he has substantial assets and substantial future earning potential. He is presented with the option of investing $8000 with a moderate probability of making a 50% return on his investment. He also believes that, even if he does not make 50%, he has a good probability of making some profit and very low probability of losing his entire investment. Jones enjoys the things that he buys with his wealth and he enjoys playing the game of investments. Given the offer of this investment, he reasons that he has substantial resources to absorb the unlikely losses that might occur. He takes the investment.

In contrast to our optimistic, risk-taking Mr. Jones, unfortunate Mr. Smith believes he is down to his last $100. He has suffered some losses recently---most of which he had not anticipated. He is offered an investment of $80, with a possibility of gaining $40 (a 50% return on his investment). Smith believes that he has little likelihood of gaining employment and he believes that he has bills coming due next week. Moreover, he attributes his dire financial straits to foolish investments that recently headed south. Jones is a "Nervous Nellie" and passes on this opportunity to invest.

These two investors---optimistic Jones and pessimistic Smith--- operate from what they believe are rational considerations given the information and goals that they attempt to pursue. The optimist pursues a maximization strategy---that is, a growth strategy---because he is willing to take risks. The pessimist---our "depressed" and anxious Mr. Smith---believes that his minimization strategy is rational, since his goal is to avoid further losses. Perhaps Smith is incorrect (or correct) about his evaluation of his current and future resources, perhaps he is unduly negative of his chances of gaining, but there is an internal logic that tells him that he cannot absorb any further losses. His "self-protective" strategy instructs him to avoid change unless there is close to certainty of gaining.

Strategic Pessimism

In the current market-of salient, unexpected, dramatic bad financial news--- we can see that investors are using what I call "strategic pessimism". What is strategic pessimism? It's an attempt to avoid any further losses by following a set of rules that will minimize risk. We can think of the anxious investor as having a "portfolio theory"-that is, a theory about the current market, the time horizon of investment (how long he can stay in), his perception of how diversified he is, his future earnings and his tolerance for risk and loss. Investors who are currently anxious-and depressed-in this volatile market of recent weeks may be utilizing what I would describe as a "depressive portfolio theory". Their goal is to minimize risk.

In the table below, I contrast the depressed/anxious investor and the non-depressed investor.

Portfolio Theories of Depressed and Non-depressed Individuals
Portfolio Concern	Depressed	Non-Depressed
Assets available	Few	Some/Many
Future earning potential	Low	Moderate/high
Market variation	Volatile	Low/predictable
Investment goal	Minimize risk	Maximize gain
Risk-orientation	Risk averse	Risk neutral/risk lover
Functional utility of gain	Low	Moderate/high
Replications of investment	None/few	Many
Duration of investment	Short-term	Long-term
Portfolio diversification	Low	High

The anxious investor believes he has few current assets-he feels relatively poor. He may also think that he will not have substantial future earnings-so if he loses, he will not be able to recover. He views the market as volatile and unpredictable---he doesn't know what will happen next. And "It could be terrible", he adds. His goal is to minimize losses, so he embraces a risk-averse strategy. In addition, he may not enjoy the gains that he does achieve (they have "low functional utility")-partly because he is anxious and depressed. He doesn't think that he can continue putting money in---he doesn't think he can replicate his "hands", continue playing the game, or take a long-term strategy. And, he doesn't think that he is diversified in his assets. For example, he may narrowly focus on a few stocks or investments and not realize that his real estate or retirement funds have significant value. He is over-focused on one investment that he views through a lens of pessimism and fear.

The pessimistic investor feeds his negativism with a string of worrisome assumptions and beliefs. These are shown in the table below. Examine this table and see if any of these fit you when you are anxious about financial markets. For example, do you view as small decrease in a stock as a sign that things will begin to unravel? Do you set a rule that you will quit early-"while you can still get out"--- and set a stop-loss order in? So, if your investment goes down 5 %, you pull out immediately. Do you think that the world is now characterized by a severe economic downturn of unknown duration? Are there few possibilities out there for further growth? Do you view small losses as permanent depletions from which you may never recover? Do you see "cost-cascades"---that is, one loss will trigger other losses as they cascade over the cliff carrying you under? Is your focus on the short-term---thinking that only what happens this week really counts? Do you lack that longer term perspective that would allow you to see ups-and-downs as part of market conditions? Do you view losses and bad decisions as irreversible--- "What goes down stays down-forever?" And are you prone to severe regret-even self-loathing-when investments don't work out for you?

Loss Orientation in Depression and Anxiety
Loss Orientation	Example
Low threshold	The slightest decrease is viewed as a loss of significant proportion.
High “stop-loss” criteria	A small loss leads to termination of behavior. Consequently, the depressive gets stopped out early.
Scarcity assumptions	The world is viewed as having few opportunities for success. This is generalized to a zero-sum model of rewards for self and other.
Depletion assumptions	Losses are not simple inconveniences or temporary setbacks. They are viewed as permanently drawing down resources.
Cost-cascades	Losses are viewed as linked to an accelerating linear trend of further losses.
Temporal focus	The depressive takes a short-term focus, viewing his investments only in terms of how they will pay off or lose in the short-term.
Reversibility and revocability	Losses are viewed as irreversible and not compensated or off-set by gains. Negative investments are irrevocable---he cannot see himself as able to “pull out” easily.
Regret orientation	Losses are followed by regret that one should have known better. His hindsight bias is focused on the assumption that he should have been able to make perfect decisions with limited information.

If these assumptions, beliefs and strategies fit your theory of investments and market conditions, you can bet that there is someone out there with a very different portfolio theory. That would be the investor, loaded up with cash, looking for an opportunity, bottom-fishing and buying up the bargains. That person is not anxious and depressed. In fact, they may feel so good about what is happening that they may actually appear manic to you.

They could be right. They could be wrong. Or they could be lucky.

Sometimes bottom-feeders in a volatile market get very lucky. And sometimes they turn out to be the "bigger sucker down the road".

Place your bets.

To read more about depressive portfolio theories, see my chapter from my book, Psychology and the Economic Mind available by clicking here.

Second Week: Accepting Uncertainty to End Your Worries

Robert L. Leahy, Ph.D. — Fri, 19 Sep 2008 08:04:55 -0700

Now that you have been recording your worries and examining whether they are productive (see my previous blogs on this), you have been able to identify which worries you can take action on and which you cannot act on. For example, you can take action on your worry about whether I will get my work done--- by taking the action of doing more work now. But you have also identified some worries that don't lead to an action plan, such as "What if no one likes my talk?" I have called the latter worry, "Unproductive worry".

But now what?

The second step in our approach is to consider accepting limitations. You and I have limitations in terms of what we can do and what we can know. Let's start with the limitation of what we can know.

Tolerating Uncertainty

In an earlier blog "But what if I'm THE ONE?" How Intolerance of Uncertainty Makes you Anxious" I suggested that many of us worry because we equate uncertainty with a bad outcome-"I don't know if I will fail, therefore I probably will" or "If I don't know for sure, then I should worry about it". You may be thinking that uncertainty means that the outcome will be negative---but uncertainty doesn't necessarily point to a bad outcome. It simply means we don't know. You might even ask yourself, "What could be the worst outcome, the best outcome and the most probable outcome?" And, then you might ask yourself what the probabilities are for these different alternatives. It may be that the probability of the worst outcome is close to zero. But then you might say, "But it's still possible". You want certainty!!!

Simply having uncertainty doesn't mean that worry is the best alternative. For example, let's say that you worry that you might lose your job. You have uncertainty about this. You can worry about it, which might make you a lot more anxious and less productive at work. Or you can think about some productive action---like networking, acquiring new skills, looking for a different job, or budgeting your finances. But no matter what you do, there still will be that uncertainty. So, after you have taken whatever productive action you can take, how do you deal with uncertainty?

Worrying to reduce uncertainty

Take a look at the figure below (from my book The Worry Cure ). If you are like a lot of worriers you start with the assumption that uncertainty is dangerous, irresponsible and intolerable. So you start to worry and collect information to eliminate the uncertainty. In your view, any uncertainty is bad. As you selectively Google disasters or examine your imagination for the worst things that might happen, you notice that you come up with a lot of potential problems. You then start generating solutions to every problem and find that none of the solutions will solve the hypothetical problem with absolute certainty. You might think you have a mole that could be cancer, you examine it, see a doctor, get reassurance, and then a few days later think that doctors are not infallible. Or you might think that you are going to lose your job, you talk to your boss, she tells you that you are doing fine, but then you say to yourself, "I don't know for sure if her job is secure". Your intolerance of uncertainty combines with your perfectionism to lead you to worry more-in search of certainty and perfection.

In the figure below, you can probably see elements of your own quest for certainty-a quest that is doomed to failure, frustration and more worry.

How to handle your intolerance of uncertainty.

I am going to expand a little on my prior blog on tolerating uncertainty.

First, ask yourself "What are the advantages in accepting some reasonable uncertainty?" You will recognize that an advantage of accepting uncertainty is that you will worry less, you can enjoy your life, you will seek out less reassurance, and you can face your fears. You will probably be less depressed if you accept reasonable uncertainty. If you are honest with yourself you might think that a disadvantage in accepting uncertainty is that you will be surprised by a bad outcome, you will overlook something important, and disaster will happen. Then you will be flooded with regrets because you hadn't listened to your worries. But the question for you is what is reasonable uncertainty? If you are looking for perfect certainty you will continue to worry. And it may be that no matter how much you worry, some things are out of your control anyway.

Second, what uncertainty do you already accept? For example, when you drive, take a plane, eat in a restaurant, interact with someone new, go to a new city, start a new project at work---aren't you already accepting uncertainty? I find that many worriers say, "I have to accept some uncertainty in those situations-or I wouldn't be able to live my life". But what if you accepted a little more uncertainty in other areas of your life? What if you expanded your tolerance of uncertainty? You might say, "I accept uncertainty driving a car because I cannot control what other drivers might do". But what if you expanded your tolerance of uncertainty to other things that you cannot control or cannot know? For example, you really cannot control and often cannot know what people think of you. What if you accepted that uncertainty?

Third, do you know anyone who has absolute certainty? Anyone? How do they live with themselves? Are they irresponsible or in danger? Keep in mind that uncertainty is inevitable. We can never know for the future for sure. There is far too much information that is unknown to us. Do you judge other people who accept reasonable uncertainty?

You can remind yourself that uncertainty is inevitable and that accepting uncertainty allows you to live your life more fully. One patient of mine finally decided to accept the possibility that he could make mistakes simply because he realized that demanding certainty was the biggest mistake he could make. Accepting uncertainty-and the possibility of mistakes-was something he could actually decide to do. "I guess I will have to accept that I could be wrong". In contrast, trying to assure that he would never make a mistake was out of his control.

Fourth, flood yourself with uncertainty. We have found that this is a very powerful technique for some of our patients. We ask them to repeat slowly, while observing the thought, "No matter what I do it's still possible something terrible will happen". I had a patient a few years ago who worried about cancer. He had been a chronic worrier about cancer for 45 years. He had regular checkups-there was nothing wrong with him. But because he believed that he had to have complete certainty, there was no medical exam that would suffice. Using uncertainty training, he began to replace his worry about uncertainty with repeating uncertainty. For example, I told him that whenever he had the intrusive worry, "Maybe I have cancer", he could either worry about it by seeking reassurance or he could repeat the worry 200 times, very slowly, "Maybe I have cancer". Initially the thought about having cancer increased his anxiety---but after he repeated it about 50 times, very, very slowly, he found the thought boring. Ironically, repeating a worried thought hundreds of times takes the power away from the thought. When you repeat the thought---like a zombie, slowly, methodically--- the thought loses its power. We have used this technique for years and it often dissipates worries.

See THE WORRY CURE for more ideas on how to handle your worry. My new book, Anxiety Free: Unravel Your Fears Before They Unravel You, will be published in April 2009.

Eight-weeks to being worry-free - Reviewing your first week: Setting Aside Your Worries

Robert L. Leahy, Ph.D. — Mon, 08 Sep 2008 07:08:55 -0700

Your Last Self-Help Assignment

You may have been following my last two blogs-- Eight Weeks to End Your Worries and First Week: Ending Your Worries. I hope you have been using some of these techniques to help yourself. Let's look at where we are.

In my last blog I recommended that you do the following:

1. Identify the same worries---over and over
2. Set aside worry time
3. List the advantages and disadvantages of worrying
4. Ask if this is a productive or unproductive worry

Let's see what you may have found.

Same Worries-Over and Over

Did you find that you have a lot of the same worries occurring over and over? For example, are you repeating the same worries about your relationship, health, work, finances, or another topic? If you are repeating your worries, then it's useful to just list them and check them off-rather than dwell on them. "Been there, done that". What has your list shown you? Same stuff? Spinning your wheels?

Worries can be delayed

I asked you to take notes on your worries. Write them down, put them off until later. Set aside worry time.

If you are like a lot of people, worry-time has helped you learn that you can "hear" a worry ("I'm not going to get my work done") and then be able to set it aside for later. You might have used some of my recommendations for setting aside a worry--- "I have an appointment with that later" or "I will write it down and go over it during worry time". Worry time takes some practice---to hear a worry, notice it, and put it off. If you have been able to do this, then you now recognize that you do have a choice. You don't have to obey a worry and respond to it right now. You may have also learned that when worry time comes around, the worry no longer bothers you.

This teaches you that worry can be delayed, thoughts don't have to be obeyed, you can do something rather than worry, worries are not urgent and worries end up to be pointless. That is progress. Keep doing your worry time.

There are few real advantages to worrying

If you listed your advantages and disadvantages, you may have come up with the following advantages:

• Worry will keep me from being surprised.
• Maybe I can solve the problem.
• Maybe there is something I overlooked, so worry will help me find it.
• Maybe worry will motivate me to work hard.

But has worry really been helping you?

For example, can worry really guarantee that you won't be surprised? Aren't there some things that happen that no one can foresee? And, so what if you are surprised? What is so terrible about being surprised? And how long will you be surprised? Some worriers think that a surprise will be traumatic-or last indefinitely. But it is in the nature of surprise that it is processed and handled. If you have been trying to avoid surprise by worrying in advance, you have been wasting a lot of your effort. The research shows that 85% of the things that worriers worry about have a positive outcome.

And you probably think that you aren't any good at handling problems that actually occur. What is the evidence that you have been able to handle problems that occur? Have you ever adapted to a break-up, a loss, an unexpected bad outcome? You may be harboring a belief that you are incompetent, but you may be more competent at solving real problems. Worriers are actually good at solving real problems. They just aren't that good at solving problems that don't exist over which they have no control. Worriers can't do the impossible.

Solving real problems when they occur is enormously helpful. But you don't have to solve every problem that you can think of. Or do you?

If you think that worry will help you solve a problem, then make your TO DO LIST now and carry it out. What is the actual behavior plan that your worry suggests? For example, I have to give some lectures and workshops next month so I had a problem to worry about--- I don't have a plane reservation. I solved it by going on-line and making a reservation. I worried for two minutes, solved the problem and now it's done. But I can't bother myself with useless worries that I cannot do anything about today---such as, "What if no one likes my talk?" There is no TO DO TODAY.

Worriers often think they have overlooked something. Now if you look at your list of worries you have found out it is the same list over and over. Worriers often worry to REMIND THEMSELVES. I suggest simply keeping a written list of things to remember and things to do, set it aside, and put off the worry to worry time. You don't have to keep nagging yourself.

Doing something is better than worrying about it

Worry can motivate--- but you have to ask if it is actually motivating you, simply scaring you, or making you so anxious you can't move forward. The real proof of whether it motivates you is if you are spending more time worrying about something or more time getting something accomplished. I am currently writing a new self-help book on depression. I can either worry that I am behind deadline or I can start writing something right now.

Well, I'll have to leave you with that thought. I've got to write something about depression or my publisher might be annoyed.

See THE WORRY CURE for more ideas on how to handle your worry. My new book, Anxiety Free: Unravel Your Fears Before They Unravel You, will be published in April 2009.