Greed and Fear

Following are contributions from California Institute of Finance Students on the topic of “Fear and Greed”.

GreedThe complex relationship between the emotions of greed and fear has far reaching implications in financial decision-making. Herd behavior, bubbles and crashes, over/under expectations, biased decision-making, etc. are just a few examples of its role in financial markets as well as effects. How do we get to the roots of these forces in an attempt to increase our understanding is the main objective of this discussion. It is an attempt to discover the number of ways in which we can dissect this concept and examine its micro and macro structures.

http://bucks.blogs.nytimes.com/2010/03/24/how-greed-and-fear-kill-returns/

I thought this was a great article illustrating how important greed and fear are in financial decisions making. Although it is almost a year old, it is still a very timely article.

The article has a great graph at the beginning the shows a sort of “herding” affect when greed comes into play to purchase at the “peak” and then sell at the bottom. This process just repeats itself until you are broke, or you will consistently under perform the market and never realize your retirement dreams. The article gives an example of this exact theory during the dot-com era with the movement of billions of dollars in and out of mutual funds. It then takes us to 2008/2009 when over 80% of money that went into Mutual Funds, went into Bond funds. Do you realize how much money was forgiven because of this. People sold all of their stock funds at the bottom
and missed out on a 50% run the next 6 months.

Fear and Greed play a huge part in the investment decision making process. Too many individual investors fall into this negative way of investing. I also read an article in Forbes that states the large institutional money managers just wait for this to happen. They is their bread and butter. They wait for the greed, fear, and herding to take place so they can jump in when everyone else jumps out. Not to say these money managers are don’t fall victim to this same idea once and a while as well. We as planners must be here for the clients to help them understand how much of a losing strategy this is. Taking all emotion out of the picture if very difficult on a consistent basis. In 2008 when clients saw 50% of their portfolio disappearing they thought it would never stop. Fear jumps in and they sell into bonds or money markets. They sit on the “sideline” watching the market recover and they have made nothing. They are still to scared to jump back in. This is
where the long term investing approach becomes more and more important. The market is cyclical and will always be that way. You cannot let greed and fear get in the way of your long term investing strategies. Clients that did nothing over the past 3 years fared the best. I am sure they were very scared, but they stayed on their course and didn’t let short term news and greed or fear, affect their long term goals.

This is all to apparent with Vanguard clients as well. Many of them are just now jumping back into the equity markets. Is it too late? Well that depends on their overall objective for this investment, but what about the past 3 years when they were sitting on the sidelines?

Student W

 

It has been said for quite some time that greed and fear lead the market up and cause it to crash, respectively. Both of these labels have a negative connotation and lead people to believe that only the greedy buy and only the fearful sell. In its most basic sense, this is true. People
who would like to make money buy assets in the expectation that they will rise in value, thus the speculator can sell at a higher price. However I do not believe that people speculate entirely out of greed, people speculate and invest to increase the assets in which they control out of survival as well as greed. This is why we save money, isn’t it? We do not save money out of pure greed but to build up enough resources to survive a period of scarcity. It just so happens that, at times, the resources that we use to barter for products and services lose purchasing power, otherwise known as inflation. Due to this uncertitny, we must take risk in the expectation that we will at least break even.

I would also argue that selling pressure could also be caused by the will to survive and protect the resources that one has. I understand that the basic assumption is that people fear losing money, thus they sell before they are broke. However through observation I have also determined that people sell due to
uncertainty. Of course one could argue that selling due to uncertainty is the same as selling out of fear. This is if only you define uncertainty and fear as the same neurological responses. I argue that selling is not based in only fear but uncertainty as well, due to the fact that fear is an automatic neurological response triggered by some external stimuli and uncertainty is a logical progression of weighing risk and available information to make a sound decision. When there is not enough evidence to convince someone to take the risk they sell. Thus fear and greed is not the only factor used when making investment decisions.

Student J

 

The concept of fear and greed are interesting to look at. I don’t remember the quote exactly but doesn’t Warren Buffet say something like he gets greedy when others are fearful and he gets fearful when others are greedy? Fear and greed drive the contrarian investor because they typically are bullish when people are bearish and vice versa. Yet,
many would be contrarian investors lost their nerve during the recent recession. While many know not to sell when the markets are low they did.

I recently spoke with a woman who pulled her money out of the markets about half-way to its low point and did not re-enter the markets. While she agrees that she missed a great opportunity to increase her portfolio as the markets rebounded, her fear is so great that she will not enter the markets until they hit the high points of 2007. I look at the high points prior to the recession as a point of greed (I am guilty); while many agreed the markets were hot and over valued many continued to pump money into the markets rather than look at re-balancing, re-allocating, or other techniques to decrease risk exposure and maximize gains.

Greed and fear demonstrate the herd behavior we have discussed many times in class. Investors react to investor sentiment more than good technical and fundamental analysis. I feel that herd behavior is amplified during
times of greed and fear. This is demonstrated by the statistic presented 2 lectures ago that showed investors typically under perform the markets; which we learned is because investors pull out at low points and invest at high points, thus diminishing their returns.

Student A