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Sophisticated or Naive Investors? Print E-mail
General Investing Articles | Written by Robert Prechter |

Sophisticated or Naive Investors?

By Elliott Wave International's Robert Prechter, Prechter's Market Perspective
Nov 4, 2005

Has the house down the street from yours just sold for a bundle more than you ever imagined houses in your neighborhood would sell for? You might find yourself scratching your head at the amazing fact that some folks will pay much more than what a house – or a stock – may be worth.

Bob Prechter wrote about the optimistic investor psychology that posits that prices will always go higher in his book, At the Crest of the Tidal Wave. He points out that when he entered the stock market business in 1975, the typical investor was very sophisticated. Why? 'Because anyone who was still in the game after the 1968-1974 bear market either knew something about markets beforehand or had learned a lot as a result.' Bob says that many investors today are caught up in a financial mania and, as with any mania, it's not necessarily the sophisticated people who are doing all the buying. Rather, it's everyday people who don't really have the experience to do well in the markets, but who do have the optimism that all will turn out well. Here's an excerpt from his book that describes the problem with that kind of psychology.

* * * * *

Manifestations of Investor Psychology, Excerpt from At the Crest of the Tidal Wave (2000), p.179-180

Gimme that bag!

I saw two Joseph Granville 'shows' in the late 1970s and early 1980s when this investment-letter writer was in his heyday. Granville enjoyed explaining that when buyers no longer politely ask, 'Please sell me your stock,' but instead grab your collar and scream, 'Gimme that bag!,' don't argue with them, 'Just give it to 'em!' These 'bagholders' are not only dumb, he was saying, they are coarse and demanding, too, so they get what they deserve. Today, the public is screaming, 'Gimme that bag!' to every imaginable seller of questionable paper, including junk bonds, new issues, low-priced stock funds, and re-packaged mortgage and consumer debt, stuff that would never cross my mind as a serious investment or even a sound speculation (except for a few professionals who know the game). The sellers, gentlemen all, have politely complied.

Who's to blame?

The idea, though, that the public is entirely to blame for its attitude does not wash. These are not people who choose to go to a casino because they foolishly believe in luck. The bear market may give them what they deserve for not having taught themselves something about investing before attempting it, perhaps, but in another sense, they have justifiably relied upon people they have been told are experts, the media's pick-stocks-and-forget-market-trends financial heroes, who have told them that the stock market is perfectly safe, that anyone not invested in stocks is a fool. Those people are more to blame for the public's attitude than the public itself.

Regardless of who is responsible, the public will be in a fury when the house of cards fall. To amateurs, an uptrend is normal and a downtrend is an outrage, so they will not tolerate losses calmly.

Angry and angrier

In 1994, USA Today reported some investors' perturbation that they had lost a percent or two of their money, but took the step of assuring readers that there were only four reasonable courses of action: (1) Do nothing, (2) keep buying, (3) diversify into more funds, including foreign funds, and (4) adjust your asset allocation. Out of four options, not one was 'get out of stocks.'

The professionals and media commentators who have been catering to the public's whims, thus assuring that they will continue to have no idea what they are doing, will soon have to endure a far uglier mood. How angry will these people be when their assets are down 40% or 80%? Because the naiveté of today's investor is at an all-time high, the wrath that the public will feel at the bottom of the bear market will also reach an all-time high. When the public becomes enraged at its losses in coming years, it should remember where to direct its anger.

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