No one sets out to make a bad investment. But it happens all the time. Why? We all know that the markets can be volatile. But it’s usually bad decision making, based on intuition rather than logic, which contributes to the biggest losses. Emotions are to blame. Losses, in particular, can make investors vulnerable to emotions, often resulting in costly mistakes.
The psychology of investing is a very interesting field. Time and time again, fear and greed are the two emotions that, arguably, play the biggest part in the markets. Succumbing to these emotions can have a huge (usually detrimental) effect on an investors’ portfolio, and the markets more widely.
And here’s why…
The role of fear
“Am I going to lose my money?”. This remains, understandably, one of the main fears for investors.
All investments carry some risk. The general rule of thumb is that the bigger the potential gain, the riskier the investment. So the price for safety is a low return on your investment.
When stocks suffer large losses for a sustained period, the market becomes fearful. Investors start abandoning ship to avoid further losses, seeking low-risk, low-return securities.
On first glance, this might seem like a sound strategy. But it can do as much damage to your portfolio as throwing it all in with the latest fad. If you’re too conservative in your investing, you may never achieve your financial goals.
The role of greed
It won’t surprise you to know that most investors have a desire to accumulate as much wealth as possible as quickly as possible. Riskier investments tend to have the potential for greater rewards. But with that also comes the potential for catastrophic failure.
When things are going well and stocks rise, investors get greedy. Doubt fades, they take more risks. They want and expect higher returns. But there’s a tipping point where investors become vulnerable to reckless behaviour. They start taking too much risk. The result? They may well end up losing all the money they’d gained.
Greed can lead to investors losing sight of what they originally wanted. It’s something we see time and again. A client once asked what her return was – it was 2.3%. “That’s not much” she said, forgetting that she was previously getting 0.5%, AND that she wanted her investment to remain low risk.
This mentality can make it hard to encourage investors to stick with the long-term plan.
What’s the effect of fear and greed on the markets?
Investors, and the markets, need a bit of fear and a bit of greed for overall success. Greed can be a motivating factor if felt at the right time. But as with many things, moderation is the key. When emotions start to take hold, investors find themselves in a cycle which results in minimal long-term gains, and in some cases, net losses.
An investment is on the rise. Investors get greedy and buy more. They take greater risks. In some cases, shares become massively overprices, creating a bubble. Inevitably the bubble bursts, the markets fall. Fear kicks in. So they sell. Then things start to rise again…and so it goes on.
Investment guru Warren Buffett says:
“When others get greedy I get fearful and when others get fearful I get greedy.”
The crux of this statement is that successful investors don’t follow the herd. When everyone else was investing in tech in the early 90s, Buffet stuck with his long-term plan. He was criticised at the time, but those critics were soon silenced with the bubble burst.
It’s our job to help investors keep a level head
The fundamentals of investing don’t change. There is always an inherent risk. Stock markets are volatile. But keeping a long-term view is absolutely crucial. You have to learn to ride the waves. Stick to the game plan.
So, whilst we like to help our customers make the most of opportunities within the markets and, equally, avoid real areas of danger, we try to stop them getting swept up in the latest craze.
We help clients choose a suitable asset allocation mix, based on your appetite for risk. There is no right or wrong. It’s very personal. We find a way to combine greed and fear at just the right levels to allow investors to take on risk, but not too much. You need to desire growth, but not at any cost, and you need to fear losses, but not in a crippling way, for your investment to be a success.
Ultimately, you are the decision maker. We are the rational voice that helps sooth fear and moderate greed to help prevent emotion getting in the way of good, sound, long-term investment decisions.