This week, J. Bradford DeLong published a piece on the Project Syndicate website titled "The Economic Costs of Fear." The University of California, Berkeley economics professor juxtaposed real returns in the Standard and Poor's 500 index with the negative annual real interest rate in five-year Treasury Inflation Protected Securities and hypothesized as to the reasons why people are not investing in stocks.
It's a good question: Stocks are riskier yet offer the chance for some return, whereas TIPS at today's rates are very safe yet offer investors the certainty of losing purchasing power. DeLong gives a 7 percent real return on the S&P 500; the current five-year TIPS yield is -1.05 percent, according to Treasury.gov.
Bankrate's April Financial Security Index asked consumers if they were more likely to consider investing in stocks as a result of today's very low interest rates on savings. More than three-fourths of the respondents said no.
DeLong posits that people may be avoiding stocks for two reasons. First, stocks are good now, but will that continue? A repeat of the downturn in 2008 would be unbearable, and they don't trust that it won't happen again and soon.
From the story:
These investors do not view the 7 percent annual return on stocks as an average expectation, with downside risks counterbalanced by upside opportunities. Rather, they see a good-scenario outcome that only the foolhardy would trust.
The second reason he gives reasons that the current rate of return to be found in the stock market is reasonable, but the downside risks are simply too great.
"The burden of existing debts is high, and investors’ key goal is loss-avoidance, not profit-seeking," DeLong writes.
The dog trainer in me wants to attribute this to learned helplessness, the psychological theory developed by Martin Seligman in the 1960s.
His research found that when test subjects were repeatedly exposed to aversive stimuli, electric shocks in this case, and were not allowed a way of escaping, they eventually gave up trying to avoid pain. Even when their means of avoiding the shocks was reintroduced, they still suffered through the pain. The theory goes that once people or animals believe they have no control over the outcome, they stop trying to escape the situation.
Applied to today's investors, people may feel that nothing they do in regard to the stock market will yield fruitful results, so they would rather stick with the pain of very little return or even in some cases, predictable negative real returns, as is the case with today's certificates of deposit or TIPS.
I also think a well-planned investment strategy would give investors a sense of control. My question is, how many retail investors have a well-planned strategy?
What do you think?
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