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Fear and Greed
Old 07-15-2006, 05:08 AM   #1
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Fear and Greed

Fear and Greed

There is an old saying on Wall Street that the market is driven by just two emotions: fear and greed. Although this is an oversimplication, it can often be true. Succumbing to these emotions can have a profound and detrimental effect on investors' portfolios and the stock market.


In the investing world, one often hears about the juxtaposition between value investing and growth investing, and although understanding these two strategies is fundamental to building a personal investment strategy, it is as important to understand the influence of fear and greed on the financial markets. Leaders in the world of Behavioral Finance, Daniel Kahneman of Princeton, Amos Taversky of Stanford and Richard Thaler of U of Chicago have this to say:


Greed's Influence
So often investors get caught up in greed ("excessive desire"). After all, most of us have a desire to acquire as much wealth as possible in the shortest amount of time.
The Internet boom of the late 1990s is a perfect example. At the time it seemed all an advisor had to do was simply pitch any investment with a ".com" at the end of it, and investors leaped at the opportunity. Buying activity in Internet-related stocks, many just start-ups, reached a fever pitch. Investors got greedy, fueling further greed and leading to securities being grossly overpriced, which created a bubble. It burst in mid-2000 and kept leading indexes depressed through 2001.

This get-rich-quick mentality makes it hard to maintain gains and keep to a strict investment plan over the long term, especially amid such frenzy, or as the former Federal Reserve chairman, Alan Greenspan, put it, the "irrational exuberance" of the overall market. It's times like these when it is crucial to maintain an even keel and stick to the basic fundamentals of investing, such as maintaining a long-term horizon, dollar-cost averaging and avoiding getting swept up in the latest craze. However Richard Thaler is also an advocate of taking a small percentage of your portfolio, say 10%, and using that to “play the market” this can be profitable and keeps those who want to try new investment strategies happy while keeping a bulk of their retirement funds in safer investments.

A Lesson From "The Oracle Of Omaha"
We would be remiss if we discussed the topic of not getting caught up in the latest craze without mentioning a very successful investor who stuck to his strategy and profited greatly. Warren Buffett showed us just how important and beneficial it is to stick to a plan in times like the dotcom boom. Buffett was once heavily criticized for refusing to invest in high-flying tech stocks. But once the tech bubble burst, his critics were silenced. Buffett stuck with what he was comfortable with: his long-term plan. By avoiding the dominant market emotion of the time - greed - he was able to avoid the losses felt by those hit by the bust. Recently, Buffet is now advocating diversifying into other currencies instead of the dollar and this leads many to fear. Will Buffet’s critics be silenced again if the dollar falls and his strategy works?


Fear's Influence
Just as the market can become overwhelmed with greed, the same can happen with fear ("an unpleasant, often strong emotion, of anticipation or awareness of danger"). When stocks suffer large losses for a sustained period, the overall market can become more fearful of sustaining further losses. But being too fearful can be just as costly as being too greedy. Many investors stick to safe investments; index funds, bonds, and CD’s. This can be just as costly as the returns may not make your retirement funds grow enough over the long term.

Just as greed dominated the market during the dotcom boom, the same can be said of the prevalence of fear following its bust. In a bid to stem their losses, investors quickly moved out of the equity (stock) markets in search of less risky buys. Money poured into money market securities, stable value funds and principal-protected funds - all low-risk and low-return securities. In fact 2002 saw the largest amount of outflows, about US$40 billion, from the equity markets since 1988, a year after one of the worst stock market crashes in history, and a record $140 billion flowed into the bond market and many investors have stayed there since 2002.

This mass exodus out of the stock market shows a complete disregard for a long-term investing plan based on fundamentals. Investors threw their plans out the window because they were scared, overrun by a fear of sustaining further losses. Granted, losing a large portion of your equity portfolio's worth is a tough pill to swallow, but even harder to digest is the thought that the new instruments that initially received the inflows have very little chance of ever rebuilding that wealth.

Just as scrapping your investment plan to hop on the latest get-rich-quick investment can tear a large hole in your portfolio, so too can getting swept up in the prevailing fear of the overall market by switching to low-risk, low-return investments.

The Importance of Comfort Level
All of this talk of fear and greed relates to the volatility inherent in the stock market. When investors lose their comfort level due to losses or market instability, they become vulnerable to these emotions, often resulting in very costly mistakes.

Avoid getting swept up in the dominant market sentiment of the day, which can be driven by a mentality of fear and/or greed, and stick to the basic fundamentals of investing. It is also important to choose a suitable asset allocation mix for your age and risk tolerance. For example, if you are an extremely risk averse person, you are likely to be more susceptible to being overrun by the fear dominating the market, and therefore your exposure to equity securities should not be as great as those who can tolerate more risk.

Buffett was once quoted as saying, "Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market."
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Re: Fear and Greed
Old 07-15-2006, 06:22 AM   #2
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Re: Fear and Greed

http://www.investopedia.com/articles/01/030701.asp
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Re: Fear and Greed
Old 07-15-2006, 07:34 AM   #3
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Re: Fear and Greed

My question here is this:

Those that have attained FIRE, have they done this by simply not getting greedy and also not letting the market scare them either?

Did you stay true to a long term investment plan?
Did you not buy into the tech stock hype of the 90’s?
Do you simply DCA, invest for the long term and have a proper asset allocation?

Or did you start out start differently, lose a little, make a little and eventually develop a long term, conservative strategy somewhere along the way?

How did you invest in your 20’s versus their 30’s, 40’s, etc?

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Re: Fear and Greed
Old 07-15-2006, 08:24 AM   #4
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Re: Fear and Greed

Heh heh heh heh heh heh - entirely by accident, like my ER.

1966 - fresh out of college and ready to set the world on fire - or at least make an impression - individual stocks, raw land, gold, silver, mining stocks, REIT's(mortgage in those days) foriegn funds, warrants, low priced stocks, sector/various class mutual funds, semiprecious gems, rental RE, timberland LLC, gold mine joint venture, and maybe a few I've forgot. Never did commodities futures though - lucky me. When I was 'rich in my own mind' - dirty blonds, a penthouse, a couple sports cars - a tad high on the hog - 73-74 one wake up call - Read Ben Graham's Intelligent Investor, 1976/77 company offered S&P Index 500 in 401k.

Expensive education - although fun at times. Anywise the boring DCA low expenses index funds in tax deferred won in the end - while I wasn't really looking - dam turtles.

Probably as many routes to ER as posters to this forum - but the underlying principles are similar.

Still - sigh! - 15% in individual stocks - read the Postscript part of Ben Graham's lastest ed. of Intelligent Investor or Bernstein's 15 Stock Diversification myth. The odds are agin you but better than a lottery ticket - plus the game makes you do a lot of thunkin - er something.

heh heh heh
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Re: Fear and Greed
Old 07-15-2006, 09:19 AM   #5
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Re: Fear and Greed

During the dot.com craze my coworkers were putting all of their savings into the high flyers and giving me a hard time about my steady investments thru DRIPS into boring dividend paying stocks. I retired at 55 and they are still working. I collect over $8,000 a year in lightly taxed dividends from those stocks. A nice addition to my DB pension.

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Re: Fear and Greed
Old 07-15-2006, 09:23 AM   #6
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Re: Fear and Greed

Nicely put, d.
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Re: Fear and Greed
Old 07-15-2006, 09:37 AM   #7
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Re: Fear and Greed

Quote:
Originally Posted by PsyopRanger
Those that have attained FIRE, have they done this by simply not getting greedy and also not letting the market scare them either?
In my case, I'd say YES to the first, yes to the second, and take exception to the term "simply" because it wasn't.

Quote:
Originally Posted by PsyopRanger
Did you stay true to a long term investment plan?
Yes...and no. When I left the military at age 31 it dawned on me that I needed to think about saving for retirement. I wasn't going to get any retirement benefits from my military service, so I joined the profit sharing program at my new job. I worked up to making the maximum contribution to the plan over a few years and kept it there. As the size of that nest egg grew I began to read and understand the risks of not owning equities, keeping it all in one basket or chasing the latest hot sector. So I was around 40 by the time I began developing a real plan (hey, better late than never).

Quote:
Originally Posted by PsyopRanger
Did you not buy into the tech stock hype of the 90’s?
Definitely not. By that time I was firmly in the mutual fund balanced asset allocation camp and not a supporter of the "this time it's different" theory. However, I will admit to doing some market timing related to the Y2K hype. In the 4Q of 1999 I moved my allocation from 65/35 to 30/50/20 (stocks/bonds/cash) as a defensive move and kept that mix through the dot-com bust until mid 2003. Turned out to be a well-timed execution of financial management acumen (or more accurately, blind luck).

Quote:
Originally Posted by PsyopRanger
Or did you start out start differently, lose a little, make a little and eventually develop a long term, conservative strategy somewhere along the way?
Started out with a conservative strategy and still made a little and lost a little along the way. Fortunately over a 27 year period the made part outperformed the lost part by a healthy margin.

I will admit (heh heh heh) that on occasion the testosterone level has overcome my good judgment and I have purchased an individual stock or two. I consider those losses as tuition paid to the school of hard knocks, and I'm happy to be an alumnus who no no longer contributes to my alma mater.

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Re: Fear and Greed
Old 07-15-2006, 10:16 AM   #8
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Re: Fear and Greed

I don't think its greed that sinks people, rather its arrogance. You think you know more than everyone else and/or you think you have a high tolerance for risk. Then you go all-in in the lastest fad stocks or trends.
Also it take a lot of time doing mostly nothing to build up a big account. Its taken me over 20 years. If you don't have other outlets or hobbies your going to be tempted to trade too much.
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Re: Fear and Greed
Old 07-15-2006, 10:22 AM   #9
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Re: Fear and Greed

Quote:
Originally Posted by PsyopRanger
Those that have attained FIRE, have they done this by simply not getting greedy and also not letting the market scare them either?*

Did you stay true to a long term investment plan?
Did you not buy into the tech stock hype of the 90’s?
Do you simply DCA, invest for the long term and in have a proper asset allocation?
As someone who has achieved "FI" and is a few years from "RE" I'll consider myself semi-qualified to answer your question.

Staying true to a long-term investment plan is critical. *Most folks do themselves more harm then good when tinkering with their investments. *I stridently avoid investing in the hot sector de jour, which means I skipped the dot com boom and bust of the nineties and am avoiding energy and commodities currently. *

I suspect its going to get harder *to deal with the volatility once I no longer have a steady paycheck. *Currently its fairly easy to shrug off down markets as buying opportunities (I bought some more equities on Friday). *But after retirement I'll be making net withdrawals from the portfolio so down markets will seem all the more harrowing. *

I often wonder how optimistic the annual rebalancing assumption in calculations like "FIRECalc" really are. *After three years of consecutive 20% declines in equities, how many people are really going to say "yup, its time once again to sell bonds and buy stocks. *I have to keep my 70/30 asset allocation." *But if you don't rebalance that way, your withdrawal strategy is probably going to be too optimistic (at least by historical standards). *

So in the accumulation phase, I can definitely attribute my "success" to employing a long-term asset allocation plan and (mostly) avoiding tinkering around the edges. *How well this strategy works for me over 40-60 years of retirement, has yet to be proven.
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Re: Fear and Greed
Old 07-15-2006, 10:56 AM   #10
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Re: Fear and Greed

There's only one thing the market likes more than people willing to take risks: suckers.
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Re: Fear and Greed
Old 07-15-2006, 11:48 AM   #11
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Re: Fear and Greed

Quote:
Originally Posted by PsyopRanger
Those that have attained FIRE, have they done this by simply not getting greedy and also not letting the market scare them either?
I freaked out on Black Monday – stayed up half the night watching the financial cable news reruns – saw a lot of money just evaporate. But the next day I talked with my broker – a very smart woman who I wish was still in the business – and she told me that other clients (people with “real money” I might add) had been calling her all day to calm her down. Their message was that BM was a market reacting to a lot of screwed up things going on, but nothing that was going to hurt the market long term. Stand pat, don’t sell and you’ll be made whole. It was the truth. Lesson learned – stay informed about the economy and the market and make moves from a solid base of knowledge rather than panic.

Something else she passed on, that she got from her other clients, it's all just numbers on paper until you sell. If the money you have in the market is money you can't afford to lose, or the potential profits are monies that you're counting on for the future, you're a greedy fool. Lock in profits and keep them safe, everything else is money at risk.

Quote:
Originally Posted by PsyopRanger
Did you stay true to a long term investment plan?
Did you not buy into the tech stock hype of the 90’s?
Do you simply DCA, invest for the long term and have a proper asset allocation?
Yes, with an occasional slip
Mostly not – a different broker tried his best to get me to do it, but I resisted. Called him once asking about Sysco and when he realized I was interested in the restaurant supply company rather than the router mfgr (Cisco) he was disappointed. I’m no genius, I never bought tech because I never understood why everyone else was. Near the end, I found myself surrounded by coworkers who were rolling in dough from their investments in Cisco, Enron and the like. Nice people, but I was convinced that the only thing they knew about investing was how to place a buy order and which channel CNBC was on. I remembered the story about the guy who said when elevator operators and shoeshine boys are giving out investment advice it is time to get out of the market. Eventually I started to think maybe I was wrong and decided to dip my toe in the water and bought 100K of a micro-cap fund that held a lot of tech. The tech bubble popped and I lost 30% of the 100K in the micro cap fund while taking a big tax hit at the same time. All my stodgy conservative investments took a hit with the rest of the market but came back just fine. Yet another lesson learned – when the other lemmings are running toward the cliff it is time to stop and go the other way.
No and Yes – I invest for the long term but I buy individual stocks so I tend to hold cash until I see a good opportunity. Once I’m in I have stayed in for the loooong haul (have stocks today that I bought in 1981). My new mantra is to stake out a sale price at the same time I buy – because hanging on too long to winners can be a hassle when it comes time to reallocate money and pay taxes. Portfolio diversification sometimes is a challenge, especially when I get dramatic movements in one area. I try too hard sometimes to make sales that also are good for my tax situations, but I learned that the best thing to do is make those decisions based for investment reasons and just pay the damn tax.

Quote:
Originally Posted by PsyopRanger
Or did you start out start differently, lose a little, make a little and eventually develop a long term, conservative strategy somewhere along the way?
Call me the accidental investor. When I was 22 I accidentally made a medium sized chunk of money (it was a lot for me back then, but you couldn’t buy a shack in southern California with the same amount today). And after not being able to piss it all away I followed a friend’s advice who told me to invest it. Conservative century-old bank private banking department with very reasonable fees was my choice. Most of the time after I made buy or sell decisions I went on about my life without thinking about the market. It went down and up, and sometimes I didn’t even open my statements until tax time. Eventually I saw the potential profits and started becoming more active. The lessons I learned were: to only be in the market if my timeline is really long, buy good companies with good track records and a bright future, don’t overthink it all because the market will do what it wants to do even when it doesn't make sense, and don’t freak out when everyone else is.

Addendum: In the lessons learned: There are no shortcuts. For every guy or gal that got lucky and hit it rich overnight there are legions of miserable bastards who are broke from trying the same thing. And whenever anybody tries to sell you something always remember that famous question: "where are all the customers' yachts?"
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Re: Fear and Greed
Old 07-15-2006, 01:02 PM   #12
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Re: Fear and Greed

Hmmm...fear and greed...which one does 'stupid' fall under?

Mine went half and half, then morphed. I made half my money on single company stock options and a couple of pieces of fast appreciating real estate. When the stock options matured, I sold them and bought funds and individual stocks. I bought QQQ's at dips and sold them a few days or weeks later. I had a stack of ameritrade buy/sell sheets that came up past my knees. My best kill was picking up some QQQ's near the end of 1999 and deciding to hold them past january 1st to defer the capital gain, since nasdaq 4000 made no sense to me at all...imagine my surprise when some folks were willing to take it to 5000 just before I sold and ER'ed with a years separation pay.

At the pretty obviously nutty prices in equities, I became a dirty market timer and took my money out. Paid off the house and cars. Paid off my girlfriends house and cars. Paid off my dads house. After 9/11, I figured the worst was factored in and bought some balanced funds like dodbx and oakbx, and REITS. Held those a couple of years and then moved into a wellesley/wellington split in my taxable and REITS, emerging markets, energy and precious metals in my IRA. Last year I sold everything, reaped some good numbers from the specialty holdings and decent gains from wellesley/wellington.

Now I'm mostly in lifecycle and index funds, mostly equities, prices seem fair. Autopilot.

The failures I saw were people who staying in the single company stock, failed to diversify, failed to recognize stupid market levels and frantic purchasing that had no basis in value, failed to bail buckets of money from a gushing well to cover long term capital material goods like houses and cars, and failed to cut their investing costs and complexities once they 'made it'.

Retrospect: You get rich on concentration and/or luck. Then some application of intelligence helps you grow and keep it. Diversification is key. Sounds dumb but buying cheap stuff with good value when nobody wanted it and selling it years later when the price was up and everybody wanted it.

Sooo...what does nobody want to buy right now thats at a good price?
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Re: Fear and Greed
Old 07-15-2006, 01:37 PM   #13
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Re: Fear and Greed

Budweiser.

heh heh heh heh heh heh heh - burp!
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Re: Fear and Greed
Old 07-15-2006, 01:40 PM   #14
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Re: Fear and Greed

Ah yes, the breakfast of champions...
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Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.
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Re: Fear and Greed
Old 07-15-2006, 02:21 PM   #15
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Re: Fear and Greed

I’ll support Anheuser-Busch any day, last Dec. the whole family got into SeaWorld in Orlando free for being military and we got a standing ovation and thanks from everyone during the Shamu show. Speaking of supporting them……….
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Re: Fear and Greed
Old 07-15-2006, 03:24 PM   #16
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Re: Fear and Greed

Had two Buds last night to go with some boiled mud-bugs (that's crawfish to all you yankees) and boudin with a hot Zydeco band jammin' on the stage.
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Old 07-15-2006, 03:29 PM   #17
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Re: Fear and Greed

Quote:
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Had two Buds last night to go with some boiled mud-bugs...
Why is it you need other guys to go along with you to eat bait?

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Re: Fear and Greed
Old 07-15-2006, 03:39 PM   #18
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Re: Fear and Greed

Touche on the "buds" line.

But I would have thought from your signature quotes you might understand (Texas and Gross Habits) the mud-bug attraction. It's not bait if you cook it before you eat it - you're thinking of sushi.

I guess I shouldn't ask you if you "suck da' heads".

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Re: Fear and Greed
Old 07-15-2006, 03:48 PM   #19
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Re: Fear and Greed

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I guess I shouldn't ask you if you "suck da' heads".
No way. But I will admit I don't ask "what's in it?" when I go back for a second helping of gumbo.
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Re: Fear and Greed
Old 07-15-2006, 04:26 PM   #20
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Re: Fear and Greed

I've not ER'ed yet, but close, and I've accumulated over a mil ready for when the moment comes. I didn't start until my 30's but always invested in MF's mostly those within 401(k)s for the time in my 30's and early 40's. 100% stock for the first 6 o r 7 years then into a 70-30 mix as I got older. During the 90's I was making 16 - 20 % returns per year over a 5 year period but I knew a couple of buddies at work who claimed they were doing much better. The company even added a Technology fund to the 401(k) options which was irresponsible IMHO as they simply reacted to demand. A lot of folks switched a bunch of their money into it and it tanked after only 2 years.

One of my friends lost 60% of his entire nest egg and had to put off his retirement by over 5 years. (he finally retired last summer at age 65 so he never did RE I suppose).

During the 90's I kept rebalancing twice a year which meant buying bond funds so that when the hard times came I didn't suffer much, although after 3 straight years of losses ( -3%, -4% and -10%) my resolve was certainly tested but I was selling bond funds and buying stocks to maintain by chosen balance and the year after the 10% loss I had a 16% gain with 8% the following year.

So, I suppose slow and steady has been my method.

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