There is an old saying on Wall Street that the market is driven by two emotions: fear and greed. Although this is a simplification, it is often the case for many investors. Investing your hard-earned money can be scary and at the same time can be a great opportunity to grow your wealth.
Whether you are new to investing or an experienced investor, you will always find yourself fighting the two strongest and most primal emotions of fear and greed. The most successful investors have learned certain tricks to cope with these emotions which could negatively impact an otherwise rational investor. In order to become a more efficacious investor yourself, you will need to understand how these two emotions can affect your investment decisions and what to do to manage them.
Fear tends to be the strongest emotion largely because investors don't notice how it easily seeps in and impacts their own investing sensibility...
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THE 2 SIDES OF FEAR IN INVESTING
The emotion of fear when investing can be broken down into 2 sub-categories: fear of losing money, and fear of under-performing the market, more commonly known as the fear of missing out (FOMO).
Whether it is money lost by falling out of your pocket or lost by making a bad investment, unless you have an endless supply of money, everyone understands this kind of fear.
The second part of fear is often overlooked, and much more difficult to recognize, understand, and keep in check. While this should be irrelevant to a rational person, the fear of missing out, under-performing, or not doing as well as your peers can often times override a person’s better judgment.
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GREED IS GOOD... SOMETIMES
Greed is an easier emotion for most people to understand and is not quite as strong an emotion as fear, but it can also make people act in ways they shouldn’t. Greed can also be separated into 2 sub-categories: greed to make more money, and greed to keep it.
The one side of greed is to make more money. This is a driving force for many people; however, it can also cause people to do silly things. The other side of greed is the need to keep your money and is closely related to the fear of losing money. Many people don’t address this side of greed. It can be very detrimental to long-term returns.
The main reason why investors panic when their stock prices fall is that they violate one of the golden rules of investing – only invest what you are willing to lose. If you end up losing money you were willing to risk anyways, the pain is much less than losing all of your money. In order to avoid a potentially devastating loss, only invest the money that you are willing to lose and be sure to save the money that you cannot afford to lose.
The financial media is unlikely to help you either. Much of the information is only speculative in nature, and everyday there is some news about what the market, or rather what everyone else, is doing. When asked why he lives in Omaha instead of New York City, Warren Buffett said he wants to be as far away from the "noise" as possible so he can think, and come up with his own thoughts, rather than be influenced by others. If you follow that kind of speculative market news, you may very well end up making a decision based on fear or greed.
HOW TO CONQUER YOUR FEAR AND GREED
The good thing about investing is that patient and consistent investors will gain more in the long run while greedy or fearful investors will lose more.In order to remain confident, you need to maintain long-term perspective about your investments. Having a long-term plan and being more patient when your portfolio is losing money will help shield you from the short-term effects of volatility.
One of the major components of a sound investing strategy is to limit your losses. You need to have concrete rules set up that help keep you out of trouble. The best way to do this is to have a stop-loss strategy in place to help protect yourself from bad investments. There are a few things you can do to help limit your losses…
- Stop-Losses
One way to work toward limiting your losses is to use a "stop-loss" on your investments. You would create a stop loss order to sell your shares if they dropped more than 10%, which limits your losses to -10%.
- Hedging
Another way to limit your losses is to "hedge" your position. There are a number of ways to do this, but when you hedge your investments properly, it doesn’t matter what the overall market or sector does, you are expecting your trade to move with one company relative to another company.
| No strategy assures success or protects against loss. |
REMEMBER, YOU ARE NOT ALONE
Just as an investor can succumb to fear, they can also become overwhelmed with greed. It is critical to know how to overcome the kind of fear and greed that can have damaging effects to any investor. Mastering your emotions while investing is a difficult challenge for anyone, but the top investors have done this. There is no one way to accomplish this goal of mastering one’s emotions; the best strategy for you may be to work with an experienced financial advisor to help remove emotion from your investing.