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DEPRESSION IS BAD not just for your health, but also for your wealth. In 2001, Prof. Robert Leahy touched on the corrosive influence of a person’s mood on his approach to the financial markets. Although intuitively plausible, his observation has never received the attention I think it deserves.
The notion of cognitive bias is a cornerstone of the burgeoning field of behavioral finance. Set in motion by the pioneering research of Daniel Kahneman and Amos Tversky in 1974, the idea that irrational thoughts and beliefs influence our choices can be seen in almost every aspect of our life—including our investment decisions.
Once dismissed by some economists as fringe concepts, universal biases like overconfidence and recency have gone mainstream. Consider loss aversion, a reluctance to part with disastrous investments to avoid locking in an ego-deflating defeat. It’s a useful heuristic to grapple with when folks may need to realize capital losses to offset capital gains and thereby trim their tax bill.
Exploring the role of personality on investor behavior could, I believe, be the next research frontier. Indeed, in this piece, I’d like to flesh out the relationship between feeling depressed and managing your portfolio. And trust me, I know what I’m talking about. You see, I suffered from clinical depression for many years and—while my investment results were satisfactory—they clearly suffered during this period.
What do I mean by clinical depression? It’s when folks experience lethargy, a gloomy mood, pronounced self-criticism and a grim outlook on life for more than a few weeks at a time. It’s not just the mild blues—the aftermath of, say, an emotional trauma like a divorce or the grief over the passing of a loved one. It’s not merely dreaming about a mental health day or being grumpy. In other words, please don’t self-diagnose. Even if you’re feeling down, you almost surely don’t qualify as clinically depressed.
My symptoms didn’t entirely sabotage a profitable, if humbling, switch from the youthful high of options trading to enlightened mutual-fund investing. Still, they undermined my investment success, and required all the ingenuity and endurance I could muster to cope with my affliction. Although depression expresses itself differently for everyone, a conversation about the strategies I used might be helpful for investors struggling with this or another psychological disorder.
Many of the investment problems created by depression fall under two headings, negativity and low energy. By negativity, I mean irritability, pessimism and cynicism. I was constantly edgy and agitated, causing undue unpleasantness for my wife, Alberta, who was supporting my halting efforts to carry on with managing our family’s finances. I retreated from my responsibilities as a father. To avoid eroding my family’s good will, I sought professional help.
Grudgingly, I came to realize my depression was distorting how I interpreted the world. To be sure, life can be prickly, but for me it was downright fiendish. I saw my investments through a dark lens. I was sure the Federal Reserve would overshoot, corporate earnings would disappoint and Vanguard Group’s funds would distribute excessive taxable capital gains. Perennially distrustful, I attributed losses to diabolical insiders.
Believing the worst would happen, I sold funds that were briefly suffering poor performance and I was woefully underinvested during the technology boom of the late 1990s. As Leahy discerned, an overly pessimistic investor is often an overly cautious investor. Checking in with family members and friends, whose perceptions were not so distorted, was soothing and reassuring.
Fatigue and lethargy are hallmarks of depression. Low energy is insidious and makes monitoring your portfolio seem like an overwhelming chore. It engenders disinterest in formerly pleasurable and essential activities. I ignored my fund investments for weeks on end, occasionally trading to relieve the doldrums.
As you know from reading HumbleDollar, benign neglect comes with an ironic twist, allowing investors to profit from a paucity of emotional trading and instead enjoy the magic of unfettered compound interest. I have a close friend who grapples with a chronic depression of his own and is unsophisticated about the market. Unknowing and uninvolved, he stood aside as his employer dutifully funded a broadly diversified plain-vanilla index fund within his retirement account for 22 years. He has outperformed me by a mile. Yet, despite all my despair and frustration, I take pride in the determination I displayed to protect my family’s stock and real estate investments.
Depressed investors often have a problem with concentration, and may resort to skimming complex articles and analyses at the expense of full understanding. In short, a bout of depression is not a good time to decipher Morningstar’s mutual-fund ratings. As is often the case with this illness, the quiet of night provided me the clarity that the grogginess of morning could not. I reserved the evening for my market reading and research.
The more jaundiced among you have probably wondered whether cognitive biases and personality effects pose a challenge to Nobel laureate Eugene Fama’s famous efficient market hypothesis. Can these two positions be reconciled? Fama has conceded that “poorly informed investors could lead the market astray” and that stock prices could become “somewhat irrational” as a result. At the same time, most adherents of Kahneman’s behavioral approach agree with Fama that the deviations from market efficiency are relatively small. In other words, the financial markets may not be 100% efficient—but most of us would still be well-advised to own broad market index funds.
Steve Abramowitz is a psychologist in Sacramento, California. Earlier in his career, Steve was a university professor, including serving as research director for the psychiatry department at the University of California, Davis. He also ran his own investment advisory firm. Check out Steve’s earlier articles.
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I know of people who have depression and it’s related drugs to help it. I have at some points been quite blue but not there in those same places as others have been. Your mental health is worth far more than what you are earning. Take care of yourself. Have faith in God and tackle both with him as he rewards his followers.
Hi
Sounds like you’ve got your priorities in the right order and ways to help you cope with the blues.
EVERYONE should invest in very low index funds like S&P 500 or Total Stock. Just look at the SPIVA results. 50 years of results that will be replicated in the next 50
Hi Kenneth
Yes, the SPIVA results are dramatically convincing. Yet there’s a subset of people who simply downplay or even ignore the evidence. I think it’s very difficult for some people to believe that expertise doesn’t matter (and after expenses matters in the wrong direction). In our culture doctors, dentists and lawyers have expertise, so why not financial advisors? The past decade has seen a remarkable reduction in mutual fund management fees and expense ratios as the consumer has become less willing to pay up for subpar performance. I think the next decade will usher in a similar democratization of advisor fees.You are very fortunate. You’ve hit upon an investment solution that works and motivates you to stay the course.
I think the Dunning-Kruger effect frequently comes into play for some people when making investment decisions. Being self aware about your strengths and weaknesses can be difficult. The “KISS” principle usually works best for investing. Took me too long to learn that!
Hi Mike
Yes, D-K very similar to Kahneman’s overconfidence and a bloated sense of internal control.But it suggests more than that. People may self-congratulate (compensate) with overconfidence as a way of restoring their ego when confronted with their own weaknesses. Isn’t it fascinating how many people reading and writing in Humble Dollar say they wish they would have gotten on the right investment path sooner? High school and college have sports, dating and fraternity hazing but no courses in personal finance.
I strongly agreed that financial literacy / financial readiness is a glaring blind spot curriculum topic within our K-12 education system.
For the last few years I have enjoyed volunteering at a local high school, instructing a 4 week / 4 session “financial readiness” seminar for juniors and seniors. In all candor, a good bit of the “10 things I wish I had known in high school about money” curriculum that we cover could have easily been gleaned directly from the archives of Humble Dollar. Since this class awards no credit, it has the added benefit of being a low-stress “learn for the sake of learning” opportunity for the kids who’ve elected to sign up. Word of mouth among the students has steadily driven up the registration numbers, so this semester we had to cap registration at 25 to allow more time for group discussions and questions – rest assured, today’s teens have lots of questions about money.
It’s highly likely that I stumbled onto my life’s calling as a volunteer instructor on financial topics when I retire at the end of this decade. Clearly, a serious need exists for real-life “kitchen-table” level conversation with teens and young adults on the fundamentals of personal finance: savings, investments, taxes, insurance, etc.
I firmly believe most HS guidance offices would welcome the chance to bring some “real-world” experience on the topic of personal finance to their students. Those of us blessed with decades of first-hand experience handling (and on occasion…mishandling) our personal finances can have a significant impact by sharing some of our learnings with the next generation.
I just retired from a 26 year career teaching High School Social Studies in a very large and well known suburban district outside Washington DC. The Social Studies Department in the school whwere I taught offers a one semester course in Personal Finance to Sophomores through Seniors. It is one of the most popular electives offered in the entire school. Kids rave about it. The course is not taught in every HS in our district, so the student member of our county’s Board of Education fought to make Personal Finance a required elective. She unfortunately did not prevail, but she did open the eyes of the adult members of the BoE to the fact that our students WANT and DESERVE financial literacy.
Thank you for providing that knowledge on a volunteer basis where you live!
Hi Newsboy
What a clear statement of need and solution. You should be admired and emulated. It gives me an idea of how I myself may want to contribute to my community.
Thanks Doc.
Your final sentence “most of us would still be well-advised to own broad market index funds” is a great comment on creating a foundation for a actionable investment plan that most of us wish we had learned sooner in life. I enjoy your knowledgeable commentary on the why.
Best, Bill
Wow, that was also the gist of my own personal journey. In my case I carried on my rebellion for far too long. As you say, many of us would be a lot closer to wealthy if we had accepted that trite but profound simple wisdom. By the way, I can’t accept kudos for that last sentence. I have a great editor!
Without any professional qualifications involved, just observing people, I would buy into the link between depression, personality and general behavior and making decisions about money in a minute.
If we consider the whole person making all types of decisions every day, how could it be otherwise?
Hi Richard
Glad you agree, but it’s fascinating how so many of us don’t want to accept it. Maybe it’s too frightening because it implies loss of control. As you’ve just shown, professional qualifications are not a prerequisite. I think it involves self-awareness, humility and wisdom about people. Not incidentally I admire many of your contributions to Humble Dollar.