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.”