Looking back at 2008, there's one thing — beyond all of their money — that most investors probably wish they had: nerves of steel. For now, it seems investor angst has given rise to short-term pessimism. But what's surprising is that many people also feel optimistic about their financial future.
The last two weeks of the year are typically a quiet time on Wall Street when the stock market hardly fluctuates. So far, the Dow Jones industrial average has been hovering in the 8500 range (on Tuesday, it closed at 8419.49, down about 1 percent).
But no holiday lull can make up for the steep losses investors have suffered this year — the Dow is down 36.5 percent year to date (it closed out 2007 at 13,264.82). And whatever amount of confidence investors still had in long-term investing was dealt another blow by the massive scale of the Madoff scandal.
Wall Street money manager Bernard Madoff's alleged $50 billion Ponzi scheme is likely to be Exhibit A at any future congressional hearings into how investment professionals and the Securities and Exchange Commission — the federal regulator that's charged with overseeing them — could fall down on the job.
An Erosion Of Confidence
Coming on the heels of the global financial crisis, the Madoff scandal is "one more nail in the trust coffin," says Hersh Shefrin, the author of Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing.
A big reason investors pay money managers — whether they're affiliated with a Wall Street firm or a mutual fund — is so that somebody else will captain the ship responsibly, preserving capital and steering the nest egg away from any icebergs.
"I think the whole Madoff scandal has really put people over the top because they're saying to themselves now, 'Can I trust anybody?' " says Richard Salmen, the president-elect of the Financial Planning Association and a senior adviser for GTrust Financial Partners in Topeka, Kan.
Crisis Weighs On Investment Psychology
Confidence gave way with the implosion of Bear Stearns, Lehman Brothers and the sale of storied firms like Merrill Lynch, says Shefrin, a professor of finance at the Leavey School of Business at Santa Clara University.
"Once that lack of trust pierced the system, it's like a cancer and everything dries up," Shefrin says.
Gallup's index of investor optimism fell to a record low — negative 49 — for the period from Dec. 16-18. And 2008 marks the first year since the index's creation in 1996 that Gallup has seen a negative number, says chief economist Dennis Jacobe.
"I think it's the cumulative effect of everything," he says. That includes the financial crisis and then some. Rising unemployment and the plunge in sales don't bolster anyone's confidence, he says.
It's no wonder that 61 percent of Americans believe their personal finances are in a fair or poor state — the highest level of dissatisfaction in nearly 16 years, according to a survey conducted in early December by the Pew Research Center for the People & the Press.
Shefrin says investment psychology shifts during a crisis. "We move from this free-market laissez-faire perspective to something that says we need to have very strong regulation in place," he says. The trick, however, is finding the right balance.
Checks And Balances
"We've been having conversations with clients, reassuring them about how we handle money and that there are checks and balances," says Salmen, who has fielded calls in recent days from clients as far away as Saudi Arabia.
Salmen says he expects that Congress will weigh in with "some of the most sweeping legislation since the 1930s" to require more disclosure by hedge funds and other investments.
But for now, he's advising clients to keep their money in stocks. Leaving now, he says, would lock in their losses. What's more, there's little money to be made in certificates of deposit or bonds; Treasury yields went down to zero just in the past week, and real estate and commodities aren't attractive either, Salmen says.
"It's not like there's an easy solution," he adds.
"Most [investors] are not going to leave the stock market at this point because they have a belief that the only way they can get to the goals that they have is to participate in the economy," Salmen says.
But for financial planners and money managers who are paid fees to protect and grow their clients' principal and to prognosticate, it's far from an easy sell right now.
Short-Term Worries, Long-Term Optimism
Gallup's poll found that 47 percent of people are pessimistic about reaching their investment goals in the next year (33 percent said they were optimistic).
The depth of worries hit investors in November and December — just in time for the holidays — and Gallup's data suggest "pervasive pessimism among upper-income Americans heading into 2009," Jacobe of Gallup says. That's not good news for any number of industries including U.S. automakers or retailers.
American investors, however, seem to be buoyed by the prospects for the future. Fifty-six percent of the people surveyed by Pew predicted they would be in better financial shape a year from now.
And Gallup found that 57 percent of investors said they were optimistic about attaining their personal investment goals over the next five years.
"What is surprising is that there's still some optimism among investors," Jacobe says.