Out of the Comfort Zone

Fear and Contrarian Investing in Uncertain Times

You may have found in recent months that simply checking the movements of the markets, or turning on a business news channel is an exercise in psychological discomfort. During periods like these, investors are bombarded with reasons to mourn recent losses and to fear for the future of their investments. This information overload combines with our human natures and fertile imaginations to create disaster scenarios that can have the steeliest captain of Wall Street cowering under his bed. Unfortunately, given enough fearfulness, investors may become too focused on avoiding a new catastrophe, and so let opportunities for long-term gain pass them by.

Comfort Zone

It’s easy to see how many of these emotions (especially those which occur along the bear-market slope of the graph) market participants have gone through over the past year. The question, for our purposes in this paper, is to analyze how these understandable (and, indeed, unavoidable) emotional states may impact our ability to follow through on the solid investment ideas that we formulate during more stable or positive periods in the markets. And that analysis must begin with a quick look at the evolutionary underpinnings of our emotional reactions.

When it comes to investing, it can be incredibly difficult to overcome our instincts and make smart decisions, especially during bear markets. This problem is exacerbated by the fact that we are also both social and emotional animals. Again, these are useful traits, but they can work against us in the investing world: the market is often driven by the herdlike movements of millions of investors, each reacting emotionally to turmoil.

Research in behavioral finance has shown a clear link between heightened emotional reactivity and below-average investment performance 1. While we know we should be dispassionate in our analysis of investment opportunities, we often make snap judgments using poor or irrelevant data. We want to make the same decisions that all other investors are making, because it makes us feel better (even though we know that the markets rarely reward those who do what everyone else is doing).

History shows us that, during market crashes, panics, and other extreme situations, making good decisions that serve our long-term interests means stepping outside of our “comfort zones.” This means ignoring the inner voice that tells us to remove all of our investments from a troubled marketplace and stash them in the metaphorical mattress until conditions improve. It means working against our tendency to remove all profit-driving risk from our portfolios and following everyone else into risk-free investments that may not even keep pace with inflation. It means maintaining long-term investment discipline while rationally determining which tactical adjustments to our overall portfolios may be most beneficial during the short-term. But most of all, it means ignoring our emotional responses in favor of our rational determinations.


Evolutionary history is not the only pressure that urges most people into irrational investing behavior, or “following the herd”. Doing what everyone else is doing is also very comforting, and helps to reduce feelings of anxiety and conflict in our own minds. On the other hand, moving in a fashion contrary to the rest of the markets can make many investors feel very uncomfortable. Being one of only a few contrarian investors who are ignoring this week’s hot stock, or investing in a proven, old-line company is a much less pleasant feeling than putting your money somewhere that all of Wall Street is trying to buy; you may feel exposed and question your own judgment. After all, it certainly seems more likely that you are wrong, than that everyone else is.

Most of us are not looking for ways to make our lives more difficult. When we consider the problem rationally, though, it’s easy to see that the slow, careful, often contrarian path is the one that is most likely to help us reach our investing goals. Conducting in-depth, unbiased, fact-based research may not be as much fun as chasing hot stocks recommended by a television personality, but it’s the best method for achieving success in our investments. Below, we have listed some of the many strategies you can employ as you strive to act sensibly in a frequently senseless investing world.


If there’s one thing that the market has consistently rewarded, especially in times of crisis, it is the willingness to sell when most people are buying, and to buy when most are selling. In both cases, contrarian investors like these are providing liquidity to the market, while those who are on the other side of the transaction are using that liquidity. At moments when almost everyone in the market is seeking to buy, it’s very likely that the market is getting crowded and that values are overinflated. The most likely result is that many investments will lose value in the inevitable correction, and that those who invested near the peak will lose out. On the contrary, when everyone is selling, the odds are good that the market is entering a panic. In the wake of panics, the smart move is to identify assets that have been oversold, and strategically invest in those. Yet consistently, most trend-following investors don’t heed this advice.

Many investors are well aware of these facts. Why, then, do they tend to buy and sell at moments when they should know they shouldn’t? As we noted above, a major component of this behavior is the fact that it simply “feels right”: buying a stock that has just experienced a significant run-up makes investors feel that they have placed their money into an asset that has a proven, winning record. Selling into a panic relieves the anxiety that an investor feels as he watches his portfolio’s value continue to fall. Sure, locking in losses hurts, but it may not be as distressing as not knowing how much farther down the bottom may be.

Unfortunately for these investors, true winners and losers in the capital markets are determined by future price movements, not what transpired in the past. Following the line of thinking described above means that many investors will find themselves using liquidity in both rising and falling markets. On the other hand, the contrarian investor who provides liquidity to the markets is buying assets “on sale” and selling them at a premium, pocketing the instinct-driven investor’s money at every turn.

Becoming a liquidity provider is not natural. It is, instead, a learned behavior, through which investors reassess their natural instincts, and reprogram the way in which they perceive investment opportunities.


Questioning our own values and assumptions is one of the best avenues through which to determine whether or not the faith you place in your assumptions is warranted. Here again, asking tough questions about our assumptions is not much fun. It’s far more satisfying to act on a hunch and anticipate a reward than it is to take the time to investigate the downside of your investment. If you need evidence of this, look no farther than the millions that people pour into lottery drawings every day, knowing that they have a far greater chance of being hit by lightning than winning the lotto.

In each of these cases, it is a good idea to understand the argument against your own preference. The object is not to make you so confused about the merits of your ideas that you become unable to act decisively. Rather, some limited consideration of the opposing side can help you to develop an additional level of conviction in your strategy (if that conviction was originally warranted), or to suggest caution if it turns out that your convictions aren’t as unshakeable as you had originally assumed. In fact, whenever you find yourself confronting what seems like a totally unambiguous investment situation, it’s probably a good idea to ask this question: If it were really that obvious, why is someone else on the other side of this transaction?

One recent situation in which money managers would have been well advised to consider the devil’s advocate position is the 2008 auction-rate securities crisis. Recall that this situation arose because many managers purchased these securities based on the perception (and recent market behavior) that auction-rate securities, which paid higher yields than a money market, also had the same tiny degree of liquidity. Meaning, they thought, that they could park funds in auction-rate securities temporarily, and earn more than they would with a traditional money market, without incurring greater risk that they would be unable to withdraw the funds in a timely fashion. As we know now, the liquidity risk was greater than they anticipated, and when buyers for these securities dried up, many managers found themselves unable to retrieve their funds. These managers would have done well to recall that there is no such thing as a free lunch, and that if something sounds too good to be true, it probably is. Auction rate securities, as it turns out, paid more than money markets because they were not, in fact, as safe.


Quick, fill in the blanks below to describe the secret of investing:
Buy _____ , sell ______ .
Everyone knows that buying low and selling high is how money is made in the markets. But what few people seem to recognize about this well-known saying is how hard it is to follow consistently. Recall that, in most cases, “buying low” means putting money into a down market, when you, and all around you, may be feeling despair at the state of your portfolio. Selling high, on the other hand, usually means counteracting the joy that you feel when the market is on a bull run, and getting out of an investment that has recently provided you with strong returns. 
Moreover, because no one can know for certain when the market is reaching a peak or a bottom, it’s likely that the outperforming asset that you sell to take a profit will continue outperforming for a while after you sell it. Similarly, when you buy into a falling market, you’re likely to see some short-term underperformance as you wait for things to trend upward. It is just as important not to be swayed by these short-term effects as it is to overcome your emotions when making contrarian investments in the first place. Clearly, then, for investors to succeed, they must look past their short-term emotional reactions and adopt a longer time horizon. Many of the best investment ideas require years to play out. Here are some guidelines that can help you to take the longer view: 
  • Set Reasonable Expectations: Always remember that, in the absence of extraordinary good luck, portfolio strategies don’t work immediately. For most investors, whether institutions or individuals, the proper planning horizon may be decades long. Even shorter-term investments should be measured in years, and never in quarters or months. This simple concept is very difficult to maintain, especially in the face of the the 24-hour business news cycle and the real-time data available to every investor over the Internet. Still, it is something that you should reinforce in your mind whenever you consider your overall portfolio.
  • Establish Benchmarks: When it comes time to review your portfolio with your investment advisor, the primary focus should be on evaluating how well the overall portfolio is tracking its designated goals. This approach can help to put poor (or uncommonly strong) short-term results in the proper perspective. Even if a portfolio or a particular investment strategy underperformed over the last quarter in relation to a benchmark or peers, it may be working as planned in context of your long-term portfolio goals. Remember that long-term investing is not a “winner-take-all” contest, and that your objective is not to “beat” other portfolios’ performance, but rather to ensure that your investments are on track to deliver the growth you expect, at an acceptable level of risk, within the time horizon you have set.
  • Customized, Diversified Solutions: Many investors find it easier to focus on the big picture when they utilize a well-diversified investment program. With proper diversification, the performance of a given portfolio segment or investment strategy is not a make-or-break affair for the overall portfolio. Recall, though, that while the inherent power of diversification helps to reduce volatility, but does not assure a profit or protect against loss in a falling market.


As we’ve discussed, a large part of successful investing involves getting beyond the emotional roller-coaster that short-term market fluctuations can induce, and focusing on the opportunities available in any given market environment. Even in the midst of major bear markets, value is being created somewhere. With the assistance of an experienced investment consultant, you can logically determine where these value-creating opportunities exist, and capitalize on them while the majority of investors are paralyzed by their fear that “the sky is falling.” 
This does not, of course, mean that you have to look at all negative events with a willfully positive, Pollyanna-ish eye. The point is not to be lulled into an overly optimistic outlook. Rather, at moments like these you and your investment consultant should take a cold, hard look at the real state of the market, and then identify those opportunities that are most likely to see their value appreciate when the market begins to trend upward again. This search for new capital market opportunities can even help to counteract investors’ feelings of despair, empowering them with the knowledge that they are planning wisely for the future for feelings of powerlessness in the face of freefalling prices. 
History indicates that when other downturns have ended, the market has tended to rally strongly. Here. again, we have reprinted tables from our “Downturns and Recoveries” KnowRisk Report . The tables below show historical performance after bear markets and other significant market events. 
“Investors who regret the opportunities they missed tend to take more risks than people who regret attempts that failed.” 
“When mental accounting gets in the way of making sound financial decisions, there’s a problem.”

In an unpublished study by two prominent academics in the field of behavioral finance, 100 wealthy investors were asked to bring to mind the financial decision they regretted most. The majority of participants reported their greatest regret was from something that they had done. Those who reported a regret of not having done something were shown to take on more risk. They generally held an unusually high proportion of their portfolio in stocks. In summary, people who regret the opportunities they missed tend to take more risks than people who regret attempts that failed.

Mental Accounting

When an investor suffers from mental accounting, he or she will mentally compartmentalize investments and not look at the portfolio as a whole. When mental accounting gets in the way of making sound financial decisions, there is a problem.

When clients view individual investments with a narrow perspective (in a vacuum) they are less likely to include various asset classes in their portfolios. This is especially evident when trying to explain the benefit of including international investments. They perceive these investments to be too risky and fail to consider the potential diversification benefit such an asset class can provide.

However, it is important to note that some mental accounting may be helpful for clients. For example, if it is helpful for clients to mentally account for investments in terms of the goals they are trying to achieve, such as retirement or college savings, mental accounting could be warranted. This may help force them to make periodic contributions.

Diversification does not eliminate the risk of investment losses.

Mental Accounting: Sum of the Parts

Different types of investments perform differently from one another, which has made it possible to lower the risk of volatile assets by combining them with other types of investments.

Individually, each component in a portfolio has its own risk and return characteristics. While the relative safety of bonds or cash may be comforting, these investments may not provide the long-term growth potential many investors seek. On the other hand, stocks may provide the greatest return, but they are more risky than bonds.

Focusing only on international or small stocks, for example, may leave investors feeling a little uncomfortable because of volatility. However, as the image illustrates, by concentrating on the whole portfolio, an investor would have experienced a risk level that was similar to bonds and yet would have achieved a return comparable to stocks.

Hot-Hand Fallacy

When an investor suffers from hot-hand fallacy, he or she perceives trends where none exist and then takes action on these erroneous impressions. People tend to look for patterns and attribute trends to methods other than simply chance.

The concept of “hot hand” is taken from a study done on the performance of basketball players. The study analyzed the outcomes of players’ shots in hundreds of games. While basketball fans believe that a player’s chances of hitting a basket are greater following a hit than following a miss, the study concluded that the outcomes of both field goal and free throw attempts were largely independent of the outcome of the previous attempt.

When selecting a money manager, a one-year return could cause investors to fire their current money manager in favor of the “hot” manager. This can lead to dangerous assumptions and predictions when investors should be focusing on the long-term track record of a particular money manager.

Hot-Hand Fallacy: Asset-Class Winners and Losers

It is impossible to predict which asset class will be the best or worst performing in any given year. The performance of any given asset class can have drastic periodic changes. This image below illustrates the annual performance of various asset classes in relation to one another over the past 15 years. In times when one asset class dominates all others, as was the case for large stocks in the late 1990s, it is easy to ignore the fact that historical data shows it is impossible to predict the winners for any given year.

Investors betting on another stellar performance for large stocks in 1999 were certainly disappointed, as small stocks rose from the worst performing asset class in 1998 to the best performing one in 1999. Similarly, international stocks were the top performers from 2004 to 2007, but disastrously sank to the worst performing position in 2008. These types of performance reversals are evident throughout this example.

A well-diversified portfolio may allow investors to mitigate some of the risks associated with investing. By investing a portion of a portfolio in a number of different asset classes, portfolio volatility may be reduced.

Hot-Hand Fallacy: Chasing Fund Performance

Investor return, also known as asset-weighted return, factors in the timing of investors’ purchases and sales. It takes into account the fact that not all of a fund’s investors bought it at the beginning of a period and held it until the end. Therefore, investor return depicts the return earned by a fund’s typical investor. Investor returns support the theories about investors’ poor timing.

Some fund companies develop numerous trendy funds that tend to attract investors chasing whatever is hot, and otherwise do little to encourage a long-term investment perspective. These types of funds tend to produce relatively poor investor returns. On the other hand, most funds with consistently superior investor returns are from shops that encourage long-term investing and discourage short-term trading.


As the preceding images and commentary illustrated, investor misconceptions can be quite dangerous. In explaining asset allocation concepts and constructing an asset-allocation policy, identifying and understanding such investor misperceptions is critical.

It is also essential to find techniques like strategic asset allocation and portfolio rebalancing to counter these misperceptions and to educate investors to view markets and investing in a more rational and productive manner.

In 2002, Equitas Capital Advisors, LLC was established as a unique company that blends the resources of a large global corporation with the flexibility of a small boutique firm. The registered service mark of Equitas Capital Advisors is Engineering Financial Solutions® and the purpose of Equitas is to design, build, and deliver investment solutions to meet the goals and objectives of our investors. Equitas Capital Advisors, LLC located in New Orleans, has over 200 years of combined investment management consulting experience providing professional investment management services to investors such as foundations, endowments, insurance companies, oil companies, universities, corporate retirement plans, and high net worth family offices.

Disclosures and Disclaimers:
Above information is for illustrative purposes only and has been obtained from reliable sources but no guarantee is made with regard to accuracy or completeness. It is not an offer to sell or solicitation to buy any security. The specific securities used are for illustrative purposes only and not a recommendation or solicitation to purchase or sell any individual security.

Equitas Capital Advisors, LLC is registered as an investment advisor with the U.S. Securities and Exchange Commission (“SEC”) and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the advisor has attained a particular level of skill or ability.

Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author on the date of publication and are subject to change. This publication does not involve the rendering of personalized investment advice.

Charts and references to returns do not represent the performance achieved by Equitas Capital Advisors, LLC, or any of its clients.

Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses.

All investment strategies have the potential for profit or loss. There can be no assurances that an investor’s portfolio will match or outperform any particular benchmark. Past performance does not guarantee future investment success.