Moody Blues

Steve Abramowitz

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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