While fear and greed may appear to be conflicting emotions, embracing them both can enable people to become better investors unafraid of taking on some risk.
Fear can be a beneficial emotion for investors, especially ones who are in their 20s and 30s who have just started investing for their retirement. Losing money in the market when you are a Millennial or Gen X-er has its advantages, because it teaches investors to learn to be uncomfortable and not make rash decisions during a selloff.
“It is much better to make mistakes and learn from them early in life when the stakes are lower as you have time,” said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa.
Why Fear Is An Asset
Many investors believe mistakenly that they can try to time the market and buy stocks or ETFs when they are at a low price and always sell when they reach a high. This fallacy often leads to making poor investment choices or panicking when the market dips. Millennials should make mistakes early on when taking a chance is not as risky given the lengthy time horizon they have to win back losses.
“If you experience beginner's luck and make a couple of good timing decisions, you may conclude that you have unlocked the keys to the investment kingdom and that you can successfully time the market,” Johnson said. “It is better to make bad timing mistakes early in your investment life.”
Losing money in the market can have its benefits, because it teaches investors sooner that they need to diversify their portfolios. Some investors wind up having overly concentrated positions in one stock or sector when diversifying reduces the amount of risk.
“Young investors often make concentrated bets, thinking why not simply invest in their best ideas,” Johnson said. “It only takes one big bet going south to cause an investor to lose a great deal of money.”
The risk of owning a concentrated position can be massive such as the Enron employees who held a large percentage of the company’s stock in their retirement plan.
“When the firm failed, these employees not only lost their jobs but discovered their retirement accounts were also worthless,” he said.
Following the herd is commonplace but often leads to increased bias. Investors who fell prey to Black Monday last year or the massive decline in the market in January and sold large portions of their stocks or mutual funds out of fear should have stuck to their game plan instead, said Jon Ulin, a managing principal of Ulin & Co. Wealth Management in Boca Raton, Fla.
“Once you develop a resilient, diversified portfolio based on your long-term investment goals and feelings about risk, make sure to stick to your game plan through hell and high water,” he said.
Deviating from your investment strategy can be devastating because recovering from a loss can take years.
“Don’t sell out of your 401(K) or robo-advised portfolio in extreme market conditions due to fear,” Ulin said. “When trying to time the market, you need to make two critical decisions - when to get out and when to get in. Most of us can’t make one of those decisions correctly otherwise both.”
Dollar cost averaging remains the best strategy for most individual investors since selling at the wrong time often occurs more frequently, said Gary Zimmerman, CEO of MaxMyInterest, a New York-based company which maximizes cash balances for savers.
“Many people fall victim to emotions when investing and seem to have much more risk appetite on the way up than they do on the way down, causing them to buy and sell at precisely the wrong times,” he said. “If you can train yourself to ignore these emotions or better yet, capitalize on them, you can generate outsized returns.”
Why Greed Helps Investors
Greed is not always a negative sentiment if investors feel it at appropriate times, since it can be a motivating factor, said Johnson.
“As Warren Buffett says, ‘Be fearful when others are greedy and greedy when others are fearful,’” he said. “In other words, successful investors don't follow a herd mentality.”
Maintaining discipline in investing is not a simple goal, especially if the market nosedives or if experts recommend a widely popular strategy on TV or social media. The market cannot rise continually, so accepting losses is equally important.
“You want to have the courage to stay the course and even increase your exposure when seemingly every one else is bailing out of the market,” Johnson said. “You want to have the restraint to realize that markets maybe becoming overvalued when seemingly everyone else is pouring money into the markets.”
Greed can produce positive results if investors avoid purchasing certain sectors or stocks such as storage, energy or software without conducting research first.
“Don’t follow the crowd and throw money at something that you don’t completely understand nor fits your overall financial game plan,” said Ulin. “Many Millennials we speak to seem to be more focused on buying the latest fad like a cannabis stock or the next high tech IPO than developing a resilient, diversified portfolio.”
Dicey investments should remain only a small percentage of a portfolio, he said.
“We tell younger clients who really can’t resist buying a few shares in a risky investment to set up a ‘Vegas’ bucket for a small percent of their liquid net worth,” Ulin said.
Investors can find that greed is a good impetus for staying in the market and can help create “a bit more of an unemotional and callous approach” to short-term market losses and to “push through” future bear markets with more confidence, Ulin said. Emotional investing can lead to a timid and fearful approach or buying only popular stocks.
Consider that 5% to 10% swings in the market are the “new normal,” and avoid giving into the fear of losing money, Ulin said. During the past 30 years, the S&P 500 index produced gains averaging 9% a year, but the average investor has generated only about 3% per year based on investor behavior studies, he said.
Wanting greater returns or a larger nest egg for retirement is not wrong, said Steve Siebold, author of How Rich People Think. Greed should be viewed as the stimulus for performance and progress.
“While the goal isn’t to lose money, it can serve as a learning opportunity to get through those periods of uncertainty, instability and not being comfortable,” he said.
That impulse to seek gains, coupled with the measured prudence inspired by fear, creates an effective feedback mechanism in your investing psychology.
Finding a way to combine the two emotions of fear and greed allows an investor to take on risk, but not too much -- fear losses, but not in a crippling way. In a sense, just as you diversify your portfolio, you're also diversifying your strategic mindset.
And putting your money in play in the market -- even if it's not a boat load -- is an important first step to putting this effective balanced psychology to use. Even someone who saves a nominal amount of $5,000 a year can accumulate a significant amount of savings by the time they retire.
“Someone who puts away $5,000 per year every year and earns a 7% annual return will have 110% more savings by retirement age if they start at 25 versus if they start at 35,” said Zimmerman. “Starting early can make all the difference.”