Time for the Bloodletting!

Story Highlights:

• High-profile arrests of hedge fund managers have taken center stage.
• Folks are clamoring for someone or something to blame for debt investments gone bad, namely soured hedge funds with big subprime investments.
• This is a classic case of regret shunning.

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It's June 20, 2008 and we're in the secret meeting room of a high-level government regulatory body. The torch-lit, there's an eerie "Temple of Doom" feel of bloodthirstiness and sacrifice. Tensions are sky high, and all brows furrowed.

"Someone took their eye off the ball and let Wall Street take risks!" the Leader growls. "Surely someone is to blame for this subprime mess and, by extension, everything else that's wrong with the economy and stock markets today—right?" In unison, the room of bloodthirsty bureaucrats respond with a resounding "Hallelujah!"

[Queue distant beating of sacrificial tribal drums]

"Fellow worshipers at the altar of Demagoguery," the Leader continues, "It's clear we've angered the Gods of Investment Prudence. We know what must be done. We must purge our industry of those who embody risk taking with an offering of flesh and blood—we must sacrifice the hedge fund managers!"

There seems to come a time where folks are overcome by a primal urge for purity and payment for sin. The kind of bloodletting and human sacrifice normally reserved for ritual proceedings ages ago. It's modern Wall Street catechism to scapegoat—we must be forgiven our investment sins with a human, preferably pin-striped and coiffed, Wall Street virgin sacrifice.

Former Bear Stearns Managers Face Criminal Charges: Timeline
By Yalman Onaran, Bloomberg

Fugitive Fund Manager's Girlfriend Is Charged
By Nelson D. Schwartz, The New York Times

Such a mindset epitomizes what behaviorists call "regret shunning." Of course, those who intentionally mislead investors off a cliff should suffer consequences. Fortunately, such situations are few and far between. But when folks take risks they're fully aware of—like investing in certain hedge funds—they should be prepared to accept what comes with risk. And yes, even be prepared to accept significant losses. That's how capitalism and capital markets generally work—you know, with a direct correlation between risk and return.

Sadly, folks sometimes abandon all adherence to market truisms of risk and reward. Too often, investors instinctively revert to their Stone Age propensity to shun regret when faced with losses that are surely "someone or something else's fault." Regret is a process that denies responsibility for failure. Rather than conclude failure is one's own, the "regret-shunner" passes it off as bad luck or victimization. Regret shunning was and still is a main ingredient in our desire to survive and succeed as humans. Because our Stone Age ancestors shunned regret, they could muster the desire to try yet another time to slay that huge Mammoth so they could eat.

However, when it comes to investing, shunning regret is the basis for consistent mistakes. For example, if a stock goes up an investor is apt to believe he/she was a genius for picking it. "I knew it was a winner all along! Gosh I'm smart!" But if it goes down, there's an innate tendency to place blame outside oneself. "If it hadn't been for that crook CEO, the stock would've done just fine! I say fire his lying hide!"

Recent hedge fund manager lynchings are a collective form of regret shunning. Call it ritual sacrifice made modern, a collective behavioral quirk—whatever you want—it's a classic investor mistake.

To believe a few hedge fund managers are the sole cause for the state of the economy or market is preposterous. Of course, regret-shunning, blood-craving druids are all too willing to accept it and rally around each other to confirm their beliefs—and burn those witches (read: hedge fund managers) at the stake!

Don't join the hysteria. Do yourself a favor—when investing, accumulate regret every chance you get. Learn to understand and take responsibility for your own gains and losses, and you'll be wiser and richer in the end. Otherwise, the next ritual bloodletting will be your portfolio value.