Pessimism…Our Friend

We continue to see individuals fearful of owning equities due to an aversion to potential losses.   This negativity is a real positive for owners of companies (that’s you if you hold stocks) over the long haul.  The average individual investor is terrified of the market.

Investors pulled more money from mutual funds that buy U.S. stocks than they deposited for a fifth straight year in 2011, the longest streak in data going back to 1984, according to the Investment Company Institute in Washington. Outflows totaled $2.13 billion in January. Withdrawals were $135 billion last year, the second-highest total after 2008.

This post by Freakonomics captures why this pessimism makes us optimistic:

As Businessweek asks: where’s the party for this bull market?

The article, by Whitney Kisling, is interesting throughout, exposing the massive pessimism still attached to the markets despite this steep recovery. It is well worth a read for anyone who believes (or wants to believe) that behavioral economics has a lot to teach us about real-world investing behavior. The money quote:

“What you’re seeing is a gigantic exercise in behavioral finance,” says Brian Barish, president of Cambiar Investors, referring to studies that show investors feel the pain of losses more intensely than the pleasure of gains. “The ability to scare the hell out of people is much greater than the ability to attract them to equities.”

He is talking about what’s known as loss aversion. Believe it.