Suddenly, in the past few weeks, the markets have looked a lot scarier to a lot of nonprofessional investors.  Why?  The answer probably has something to do with human psychology.

 

An Australian company called FinaMetrica has been giving lay consumers a scientifically-designed risk profile questionnaire for the past 12 years, helping financial advisors evaluate whether their clients are natural risk-takers or the kind of people who feel more comfortable if their money is stuffed safely in their mattress.  A closer look at the responses, including 2,586 individuals who took the test before and after the recent bear market, shows something surprising: people were no more risk-averse after they had been clawed by the worst bear market since the Great Depression than they had been before.

 

Chances are, you're less excited about taking market risk now than you were in, say, the early months of 2007, so these results seem impossible.  But the FinaMetrica people offer a plausible explanation for their results.  They say that there are three components to your willingness to expose yourself to the ups and downs of the market.  Two of them changed after the market downturn, and one of those two has recently changed again.

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People in other countries think we Americans are a little weird in our work habits, and they may be right.  The web site Expedia.com has recently conducted its ninth annual survey of international vacations, telling us how many vacation days are taken by workers of different countries.  French workers get the most--38 days a year, on average, although they typically only take 36 of them.  Italians receive 31 days, although, on average, they leave 6 of them on the table.

 

Americans?  The web site reports that "throughout the eight years that the Vacation Deprivation survey has been conducted, the U.S. has long-held the dismaying distinction of being the country with the worst vacationing habits."  Our workers, on average, receive 13 days of vacation time, less than any country in the developed world, including Japan (15), Australia and Canada (19 apiece), Germany (27) and Britain (26).  Even so, more than a third of Americans don't take their full yearly allotment of vacation days; in 2009, the Expedia study found, we give back a total of 436 million of them. 

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Have you ever felt anxious about your investment portfolio?  Who hasn't?  A recent presentation at one of our professional conferences pointed out that five out of every six years will produce a stock market return sequence that either triggers anxiety or smacks your portfolio so hard that you wonder why you ever trusted the markets to begin with. 

 

This is normal.  Many people simply cannot handle stock market volatility, which is why the people who can have, historically, tended to make more money, over multiple ups and downs, than the people who kept all their money stashed away in Treasury bonds.  The question is: is there better way to handle the inevitable anxiety that comes with buying stocks?

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The Hidden Source of Returns

 

The biggest problem with investment returns is that they're posted daily--or, in the case of the recent "flash crash," every hour or so. 

 

Why is this a problem?  Because it implies that what happened yesterday or the day before is meaningful to your financial life, and is important information for future investment decisions.  People all over the world struggle with figuring out the relevance of last week's or last month's or last quarter's investment returns, and the cable investing channels and newspapers feed the confusion by trying to explain yesterday's downturn in terms of housing or unemployment data, and project tomorrow's returns based on interest rates and earnings reports.

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Is diversification dead? Or are we looking in the wrong places?
The financial planning world is abuzz with discussions about whether diversification--that is, holding different kinds of assets in a portfolio--works as well as we thought it did. In 2008, the indexes representing U.S. and international stocks, commodities and real estate all went down. In 2009, they all went up. The idea that some assets zig while others zag--leveling out the rollercoaster ride of market ups and downs--seems to be broken.

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