In this issue I would like to take a look at public psychology toward the stock market.
This is important not only because so many market participants are relative newcomers, but
because some of the patterns of thinking typical of public investors are ones even the most
experienced investors must struggle against. To get a sense of the kind of thinking that goes into
many investment decisions, I will use a fictional character named Steve and trace his behavior
throughout the stock buying and selling cycle. This name is chosen entirely at random, of course,
and does not refer to any living individual.
A TALE OF THE PUBLIC INVESTOR
Steve had grown up believing that the stock market was unsafe. This was a largely
unspoken understanding. His parents seldom mentioned the market, and the few comments they
made were largely negative. “Racket.” His father often muttered when the business news focused
on the stock market. “And tomorrow it will be down a hundred points,” he would add if the
commentator mentioned that the market was up that day. As Steve got older he gradually learned
that his father’s parents had lost half of their life’s savings in the Great Depression because of
some bad investments. And as bad as that was, it was better than those who held even longer.
Steve’s grandparents had at least enough sense to get out in late 1930 before the worst of the
damage had been wrought. Many of their friends had lost virtually everything. The lesson was
simple. If you want to keep what you have, don’t play the stock market. It’s a racket, and worse
than gambling, because at least at the casino you know what your odds are going into the game.
Steve had only once questioned the wisdom of this. When he was a teenager, he had
developed enough of an interest to at least follow the Dow Industrial Average, perhaps out of
fascination over the importance that seemed to be attached to it by the news commentators. No
one explained why it was significant, yet there seemed to be an upbeat feeling when the average
was up, and a sense of malaise when the average was down. For about a year he watched it, and
found it had been climbing very steadily, rising from 1774 in September 1986 to around 2500 a
year later. But right about the time he was beginning to question his father’s wisdom about the
market, he was confronted with the crash of October 19. His parents were out with friends and
Steve was eating the dinner his mother left him. Almost as an afterthought, he turned on the
television to watch the news. Dan Rather came on as he normally did, and, with no fanfare,
broke the story that the stock market had plunged over 500 points in a day’s trading. Steve stood
slack-jawed as he realized almost the entire gain he had seen since he had begun following the market had been wiped out in a single day. In an instant, Steve’s interest in the market
evaporated. His father had been right all along. Steve vowed never to place a dime on the
market.
After completing college, Steve got a job as assistant manager of a large department store
in the suburbs of Boston. It was a good position, with benefits, and a surprisingly high salary. As
Steve was not a big spender, felt no need to drive an exotic car, nor to live in a fancy apartment,
he found he was easily accumulating savings. In six years his savings account had ballooned to
nearly $100,000. Once he approached this limit, it caught the attention of one of his friends,
named Tim. Tim was dumbfounded that Steve would simply have his money tied up in low
interest savings account.
“You should diversify.” He said, “this isn’t a good way to manage your money.”
“Diversify into what?” Steve said.
“Bonds at least.” Tim replied. “Or better yet, stocks. Stocks do better than anything else
in the long run.”
“I’m not doing stocks.” Steve said simply.
Tim saw the look in Steve’s eyes and decided not to push the matter.
“Listen.” Tim said, “Just spend the next year following the market. Don’t spend any
money. Just watch.”
“I’ve already done that.”
“And?”
“It fell through the floor.”
