Have You Accidentally Joined the Investment Herd?

Even if you've mastered your own emotions, fear and greed could still be hurting your investments...

IN FINANCE, 'window dressing' refers to what fund managers do to your investments on the last day of the quarter. That is, they buy stocks they previously weren't interested in to make themselves look better for the upcoming quarterly report, writes Greg Canavan for the Daily Reckoning Australia.

Don't want to be seen holding too much cash at the end of the quarter? Then buy stocks. A bit too underweight in a popular sector? Then switch out of something daggy to buy the latest fashion. Window dressing it is.

It's all tied to market psychology. There are many professionals who are wary of this rally. But they have to participate anyway. It's a risk to their business if they don't.

One quarter or two of bad performance and money starts heading for the exits. Asset consultants, or whatever they're called - the gatekeepers of hundreds of billions of Dollars in superannuation funds - start asking questions. They may put the fund on hold. Hence the scramble for short-term performance is a constant pressure in the world of institutional funds management.

But you don't have to do this. You don't have to succumb to the same pressures. If you have the knowledge and conviction to manage your own money, you have a big advantage over the professionals.

In his recent quarterly letter to investors, legendary fund manager Jeremy Grantham made this exact point.

By far the biggest problem for professionals in investing is dealing with career and business risk: protecting your own job as an agent. The second curse of professional investing is over-management caused by the need to be seen to be busy, to be earning your keep. The individual is far better-positioned to wait patiently for the right pitch while paying no regard to what others are doing, which is almost impossible for professionals.

The reason why investing is so hard is not because of the market. It's because of you. When it comes to investing, here are the emotions that will erode your wealth: Impatience, greed, fear and laziness.

If you can keep those things in check, you're sorted. It's why Warren Buffett has done so well in the stock market. Yes, he knows the difference between price and value. But it's his mastery of his emotions that makes the real money.

Of course, trying to understand what's really going on in the market can be daunting for the part-time observer. That's why so many people (including lazy full-time watchers too) take their cues from the price action. 'If the market's going up, things must be improving!'

That's certainly the sentiment of the day/week/month. And as the market moves higher, more and more 'investors' succumb and get sucked into the vortex.

Our favorite argument from the bulls is 'what about all that cash on the sidelines...it must go somewhere.' Well, there is no such thing as a 'sideline' in financial markets. Everyone is in the game. If you sell cash and buy shares with the proceeds, someone, somewhere steps in and holds that cash. It doesn't just disappear.

(Actually, physical gold is the only sideline investment you can make. It's outside the 'system'...that is, the banking system and it's no one else's liability).

If everyone exited cash by getting out of their term deposits, what would happen to the banks? Australian's increased holdings of cash since the global financial crisis have helped the banks immensely by funding their mortgage books. Take that 'cash' away and the banks still have to fund their assets. It would force them to return to the dreaded wholesale funding markets and obtain 'cash' from there.

The only way for cash to leave the system is for its originators, the central banks, to take it out. They do this by selling assets on their balance sheets. Clearly, that is not happening in any part of the world right now, and it won't be for some time.

Risk assets are increasing not because cash is moving in from the sidelines to buy 'bargains'...it's because of central bank monetization of assets, which adds more cash (liquidity) into the game.

More than anything, this money printing changes investor perception about what is actually taking place. The mood changes and investor psychology becomes buoyant. People are suddenly more willing to buy what they rushed to sell only a few months ago. The herd changes direction.

This change in mood has added many more trillions to stock market values than Ben Bernanke or Mario Monti could ever achieve. Liquidity is not so much about the volume as about the 'rush' that it provides.

So, do you want to run with the herd or get out of the way now before it suddenly changes direction again? You're either in this rally because you genuinely believe it or you're just riding the momentum, betting you can get out the door first when someone yells fire.

As for us, we hate herds. They're scary and make us nervous. They're dumb too. And as dumb as we are, we'd prefer to be wrong by ourselves. You learn much more from the mistakes you make on your own.

We'll leave you today to ponder one of our favorite quotes, from Gustave Le Bon's, The Crowd - A Study of the Popular Mind

The masses live by, and are ruled by, subconscious and emotional thought process. The crowd has never thirsted for the truth. It turns aside from evidence that is not to its taste, preferring to glorify and to follow error, if the way of error appears attractive enough, and seduces them. Whoever can supply the crowd with attractive emotional illusions may easily become their master; and whoever attempts to destroy such firmly entrenched illusions of the crowd is almost sure to be rejected.

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