Fear and Greed : The Biggest Impediments to Investing Success
by Rachna Bijlani, CFP®
October 21, 2019
In my experience, most investors fall within a spectrum where one end consists of people who are too afraid to invest for fear of loosing money and at the other end there are those that are willing to throw caution to the wind and recklessly chase high investment returns. Most investors struggle to find that sweet spot somewhere in between the two ends of the spectrum and those that mange to find that happy medium, are usually the ones with success stories to tell. Fear and greed are two demonic instruments that mess with our logic and ability to reason and drive us to make less than optimum investment decisions. Let’s try to better understand their modus operandi to increase our odds of fighting and overcoming these obstacles. I am presenting a completely hypothetical situation which reflects the influence of fear and greed in our investment decisions.
Several decades ago, Investor A’s dad put all his savings in a single company’s stock because that stock was a hot commodity at that time. Dad was nearing retirement and had failed to save adequately so he was now eager to make up for lost time by investing aggressively. Everyone and their dog seemed to be buying that stock and dad was afraid of missing out on a great opportunity so, without conducting any research into the company, dad decided to invest all his savings in this “next big thing”. The stock soared to unbelievable heights over the next two years and dad couldn’t have been happier! Two years down the road, dad was savoring his morning chai tea latte while flipping through the newspaper pages, when his heart skipped a beat. There was news about a scandal in the firm where dad was a shareholder, and consequently, this company’s stock took a beating. Dad panicked and liquidated his entire holding, while bearing a significant loss. The stock soon recovered from its lows after the earnings report but by then, it was too late for dad. Witnessing his dad loose most of his savings made the son (our hypothetical investor A) apprehensive towards investing in equities, and he vowed to steer clear of the stock market all his life.
Let’s analyze what’s wrong with this situation. Dad’s fear of missing out and his greed made him ignore the basic principles of investing. He gave in to herd mentality and failed to conduct proper research into the company. He ignored the need to diversify and did not stop to consider whether the investment fit his objectives. He tried to make up for lost time by taking on more risk than he was capable of handling. Groped by fear again, he decided to sell the stock on the first piece of negative news, without bothering to scrutinize the fundamentals of the company or assessing the actual effect of the scandal. Scarred by his dad’s experience, Investor A’s fear kept him from investing altogether, possibly loosing out on the opportunity to let his money work for him. He also failed to ignore the depreciating effect of inflation on his savings, which will probably require him to work for longer than he would have if he had investment income to supplement his earnings. This was an extreme example but at some point or another, most investors have to deal with the effects of biases and emotions influencing their investment decisions. Such cases are more common in times of extreme economic conditions like market peaks and recessions.
Investing without a plan is like shooting in the dark and still hoping you’ll land the target. There are no shortcuts to financial success. You need a plan that ties your financial goals and your capacity to handle risk with your investment choices. You need a plan, but more importantly, you need the discipline to implement the plan because the best laid financial plans are totally worthless if you can’t follow them through. Understand how greed and fear mess with your brain leading you to ignore common sense and make impulsive and most likely, harmful financial decisions. If you are working with an investment advisor, make sure they can help you draw up an investment plan based on your financial goals and risk tolerance and most importantly, make sure the advisor can objectively steer you away from making poor investment choices under the influence of greed or fear.