Overcoming Fear & Greed

Humans are poorly wired for investing.

Our operating system remains optimized for a hunter-gatherer lifestyle.

By default, fear, greed, and envy reign supreme. Each of these emotions can be destructive on its own, but together they can be disastrous.

As a result of our brains’ faulty wiring, the average investor sees annual returns of around 5% vs the S&P 500’s long-term 9% performance.

Human psychology works against us. Our brains want to chase ill-advised short-term strategies.

People tend to buy high (greed) and sell low (fear).

We take profits too early. We hang onto losers for too long.

Investing successfully almost always requires a conscious re-wiring of our brains.

Controlling Fear

Studies show that investors feel losses 2-3x more sharply than gains. Our losses tend to stick with us.

One big mistake people make is letting a big loss prevent future gains. My father-in-law (rest in peace) had this problem.

He got burned in the dot-com bust chasing hot names, and never invested in another stock for the rest of his life. He stayed 100% in CDs for the next 23 years, which provided low yields but let him sleep at night.

I tried to convince him to at least invest in an index fund, or gold and silver, but he only wanted cash-like instruments in a big bank. He was scalded that badly by his experience with hot tech plays in 2000.

We can’t let a bad experience taint the rest of our investing journey. Many, I would argue most, of us have a negative early investing experience. I detailed mine in The Perils of Abusing Leverage.

That first negative experience is practically unavoidable. What matters is that we learn from it. After blowing up my first account by abusing leverage and daytrading, I began investing the majority of my funds into long-term holdings.

I continued to experiment with speculative bets, and had a few notable successes. But that section of my portfolio was capped to a 15% allocation, while the majority went into steadier long-term investments.

This is a good rule of thumb for most investors. Keep most of your funds invested in long-term plays. It’s more tax efficient, involves less emotion, and is far less volatile.

But that 15% reserved for speculative investments and trades can make a major difference in long-term returns. The key is keeping it to a small percentage of your overall portfolio, especially early on while you’re still learning the ropes. If your speculative bets are working, let it grow past that 15%. But don’t dip into funds reserved for long-term assets.

This is a balanced approach to the risk/reward spectrum, and it has worked well for me.

Harnessing Greed

Greed is a double-edged sword. We need to utilize it in order to make money, but if we let it control our decisions completely, it leads to ruin.

In my mind, a little bit of greed is good. It drives us to succeed and earn returns on our money. But it can easily become a destructive force.

The key to harnessing greed is setting realistic expectations. We can’t look at the best-performing investments in the world and expect to match those returns. It’s simply unrealistic.

When a little healthy greed bleeds into envy, that’s when things get dangerous. We start to chase hot assets and markets we don’t understand. Not good.

For the most part, it’s a good idea to stick to what you know. Alternatively, it’s perfectly fine to rely on people you trust to help make decisions. A good financial advisor or expert like those we have here at Paradigm Press can offer priceless guidance.

Not everyone has the time to develop their own investment thesis and execute it. It takes an incredible amount of work, and many people aren’t well-suited for it anyway. There’s absolutely nothing wrong with that.

Conclusions

Fear and greed are important parts of the human psyche. They’ve helped our species thrive for millenia.

But in the investing world, these emotions can be dangerous. Successful investors must learn to overcome and harness these base emotions.

One closing tip. Keep an investing journal in a Google or Word document. Track your investment decisions and note why you made them. Review them every quarter or so, see what’s working, and figure out why.

This will help understand and improve your decision-making over time. In my experience, it’s been key to overcoming the fear & greed cycle.