Can Fear Make Us Better Investors?
It’s an investment dilemma. In tough markets, investors are sometimes wracked by fear and anxiety raising the question; Are either of these emotions helpful?
Feeling fear can be a healthy response to real danger for which you can prepare a plan of action. For example, if you meet a bear in the woods, this is a real danger which is accompanied by fear. As the cowboy stranger so rightly said in the “The Great Lebowski”, one of my all time favorite movies, “Sometimes you eat the bar (sic), and sometimes, well, he eats you.”
The fear we feel when confronting the bear is real and can be handled with a series of actions and a lot of praying. You don’t chase or approach a bear at close range. You shout, wave your arms, bang pots and metal objects. You stand your ground hoping the bear will go away sooner or later.
Feeling anxiety over the possibility of encountering a bear could cause you to exaggerate the danger, and lead to irrational responses like forever avoiding the woods.
In today’s modern world, the chance of meeting a real bear is unlikely, but a type of bear that investors will always encounter is the bear market.
Which emotion does a bear market instill in you? Fear or anxiety?
If you are feeling fearful, you can take appropriate action:
1. Identify the fear. If you have a fear of losing your money permanently, examine your portfolio. It is important to assess whether the failure of any one investment would irreparably harm your overall wealth, or simply reduce your future rate of return.
2. Formulate a plan of action to respond to real danger. For example, you can sell the stock, and make sure your remaining investments are well diversified. Mutual funds or index funds are a good way to diversify. Healthy fear. Healthy reaction.
If you are feeling anxious, consider the following:
You may have already diversified your portfolio, but continue to remain overly anxious and tempted to sell everything. This unwise move may cause permanent damage to your future security. It is an irrational action created by anxiety, not fear. Try to keep the big picture in mind remembering that markets and economies are always cyclical.
Extrapolation
Definition: The taking of recent current events and projecting them into the future.
I once read that in 19th century London a magistrate complained that in the not too distant future the growing number of horses would create unbearable health and traffic problems. The city would be overrun with filth and disease. This person was extrapolating the current horse population straight out into the modern era, without any knowledge of the changes that would take place just a few decades later.
In 1999, stock prices had been going up double digits for 4 consecutive years. Everyone was talking about the stock market and many were jumping in for the first time thinking that investing was easy. The media paraded a number of gurus who declared the “death of the business cycle” due to the invention of the internet. No doubt the internet has significantly changed our world, but it has definitely NOT abolished the business cycle.
In 1999, two internet companies with NO earnings, CMGI and Internet Capital Group (ICGE) were worth more than the combined value of:
- International Paper
- Alcoa
- GM
- Honeywell
- AT&T
- Eastman Kodak — Remember, I said combined!
Back then, CMGI traded at $163 and ICGE traded at $212. Today they are $3.72 and $3.85, respectively.
In 2002, after 3 bloody years of declining stock prices, most pundits and investment fortune-tellers forecasted more years of stock price declines. The Dow fell to 7,286 and many were saying it was going to 5,000. A Dow of 5,000 struck fear in my heart, I confess, but I did not react to my anxiety. Just one year later the Dow was at 9,617- an increase of 32%.
In 2005 I gave a speech to the American Association of Individual Investors, and asked this question: “If bubbles occur because of constantly rising markets, what market are people most bullish about right now?”
The answer back then? Real Estate, and we now know the danger of extrapolating a continuously rising bull market in Real Estate. It’s the disaster which haunts us now.
Let’s come back to the present day. In 11 months, this bear market has done the same amount of damage which took 3 years to accomplish in 2002. Like then you will now hear gurus and fortune-tellers parading around telling us the world is going to hell in a hand basket and prices will continue to go lower. That’s not to say that prices won’t continue to decline. No one can really say,….but don’t forget they have already come down a long, long way. There is an old saying for bull markets: “Trees don’t grow to the sky”. Bear markets aren’t a bottomless pit either so don’t make the mistake of extrapolating the recent declines to zero.
As a matter of fact if you can turn your thinking around and contemplate the idea called “reversion to the mean”, you may start to become very successful at the investing game. Reversion to the mean suggests that prices and returns eventually move back towards the mean or average.
Like a rubber band that stretches but will eventually bounce back, mean reversion suggests the same thing for stock prices —and the longer the rubber band is stretched, the bigger the snap back. This idea can give you the courage to enter this market even if it declines further from here.
Stock prices are already down 40% since the beginning of the year. I suppose they can go down a lot more, but that seems highly unlikely. Investing in the market now will have a higher likelihood of success at today’s low prices than investing when prices were much higher. At some point business will begin accelerating again and stock prices will jump quite high. To quote Warren Buffett, “Be greedy when others are fearful and fearful when others are greedy.”
Learning to avoid extrapolation, while understanding the difference between fear and anxiety, can make the difference between creating substantial wealth or losing it.
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Can Fear Make Us Better Investors?
It’s an investment dilemma. In tough markets, investors are sometimes wracked by fear and anxiety raising the question; Are either of these emotions helpful?
Feeling fear can be a healthy response to real danger for which you can prepare a plan of action. For example, if you meet a bear in the woods, this is a real danger which is accompanied by fear. As the cowboy stranger so rightly said in the “The Great Lebowski”, one of my all time favorite movies, “Sometimes you eat the bar (sic), and sometimes, well, he eats you.”
The fear we feel when confronting the bear is real and can be handled with a series of actions and a lot of praying. You don’t chase or approach a bear at close range. You shout, wave your arms, bang pots and metal objects. You stand your ground hoping the bear will go away sooner or later.
Feeling anxiety over the possibility of encountering a bear could cause you to exaggerate the danger, and lead to irrational responses like forever avoiding the woods.
In today’s modern world, the chance of meeting a real bear is unlikely, but a type of bear that investors will always encounter is the bear market.
Which emotion does a bear market instill in you? Fear or anxiety?
If you are feeling fearful, you can take appropriate action:
1. Identify the fear. If you have a fear of losing your money permanently, examine your portfolio. It is important to assess whether the failure of any one investment would irreparably harm your overall wealth, or simply reduce your future rate of return.
2. Formulate a plan of action to respond to real danger. For example, you can sell the stock, and make sure your remaining investments are well diversified. Mutual funds or index funds are a good way to diversify. Healthy fear. Healthy reaction.
If you are feeling anxious, consider the following:
You may have already diversified your portfolio, but continue to remain overly anxious and tempted to sell everything. This unwise move may cause permanent damage to your future security. It is an irrational action created by anxiety, not fear. Try to keep the big picture in mind remembering that markets and economies are always cyclical.
Extrapolation
Definition: The taking of recent current events and projecting them into the future.
I once read that in 19th century London a magistrate complained that in the not too distant future the growing number of horses would create unbearable health and traffic problems. The city would be overrun with filth and disease. This person was extrapolating the current horse population straight out into the modern era, without any knowledge of the changes that would take place just a few decades later.
In 1999, stock prices had been going up double digits for 4 consecutive years. Everyone was talking about the stock market and many were jumping in for the first time thinking that investing was easy. The media paraded a number of gurus who declared the “death of the business cycle” due to the invention of the internet. No doubt the internet has significantly changed our world, but it has definitely NOT abolished the business cycle.
In 1999, two internet companies with NO earnings, CMGI and Internet Capital Group (ICGE) were worth more than the combined value of:
Back then, CMGI traded at $163 and ICGE traded at $212. Today they are $3.72 and $3.85, respectively.
In 2002, after 3 bloody years of declining stock prices, most pundits and investment fortune-tellers forecasted more years of stock price declines. The Dow fell to 7,286 and many were saying it was going to 5,000. A Dow of 5,000 struck fear in my heart, I confess, but I did not react to my anxiety. Just one year later the Dow was at 9,617- an increase of 32%.
In 2005 I gave a speech to the American Association of Individual Investors, and asked this question: “If bubbles occur because of constantly rising markets, what market are people most bullish about right now?”
The answer back then? Real Estate, and we now know the danger of extrapolating a continuously rising bull market in Real Estate. It’s the disaster which haunts us now.
Let’s come back to the present day. In 11 months, this bear market has done the same amount of damage which took 3 years to accomplish in 2002. Like then you will now hear gurus and fortune-tellers parading around telling us the world is going to hell in a hand basket and prices will continue to go lower. That’s not to say that prices won’t continue to decline. No one can really say,….but don’t forget they have already come down a long, long way. There is an old saying for bull markets: “Trees don’t grow to the sky”. Bear markets aren’t a bottomless pit either so don’t make the mistake of extrapolating the recent declines to zero.
As a matter of fact if you can turn your thinking around and contemplate the idea called “reversion to the mean”, you may start to become very successful at the investing game. Reversion to the mean suggests that prices and returns eventually move back towards the mean or average.
Like a rubber band that stretches but will eventually bounce back, mean reversion suggests the same thing for stock prices —and the longer the rubber band is stretched, the bigger the snap back. This idea can give you the courage to enter this market even if it declines further from here.
Stock prices are already down 40% since the beginning of the year. I suppose they can go down a lot more, but that seems highly unlikely. Investing in the market now will have a higher likelihood of success at today’s low prices than investing when prices were much higher. At some point business will begin accelerating again and stock prices will jump quite high. To quote Warren Buffett, “Be greedy when others are fearful and fearful when others are greedy.”
Learning to avoid extrapolation, while understanding the difference between fear and anxiety, can make the difference between creating substantial wealth or losing it.
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