Investor behaviour is often ascribed to fear and greed. We’re fearful as prices fall, the theory goes, so we sell to stem our losses; and we’re greedy as they rise, so we buy to maximize our gains.
This is, of course, a hugely simplistic summary of emotional finance. Human beings are much more complex creatures than that. And far from being polar opposites, fear and greed are actually more closely related than you might imagine.
At the time of writing, for example, there’s talk of a market correction. Emerging markets have suffered prolonged falls, and now the other major markets have caught the jitters too. Yet just a fortnight ago, in this very blog, we were commenting on how bullish the so-called experts were being. Some were encouraging young savers to invest exclusively in equities. Hold on, we warned, remember the oldest and best investment advice of all: diversify.
How quickly, you might say, greed turns to fear. In the world of investing, the atmosphere can change almost overnight. But are the emotions driving investors’ behaviour really so different now than they were a month ago?
In fact, fear probably played as big a part in the run-up to the correction (if that indeed is what it turns out to be) as it’s playing at the moment. It was simply a different type of fear. With markets rising, the fear then was that by staying on the sidelines you’d be missing out on further gains. In the week before Christmas 2013, investors poured $2.6 billion into equity funds worldwide.
The problem is that the higher markets rise, and the more relaxed the commentators seem about the long-term outlook, the riskier investing becomes. When the markets are in the doldrums, and fear abounds, that’s when investing, ironically, is safer.
2009 would have been an excellent time to buy equities. Compared to now, shares were at sale prices. Yet that was just the point at which investors largely lost their appetite for them. Year on year, as markets headed gradually upwards, the market gurus remained overwhelmingly cautious. Then eventually, in 2013 - the fifth consecutive year of positive stock market returns - the mood changed, and the consensus was that equities were a good idea after all.
Such behaviour is, of course, completely illogical. As Carl Richards points out, we don’t behave like that when buying anything other than shares: “Imagine walking into a car dealership,” says Richards, “and the sales representative greets you with: “It’s your lucky day! The car you want is now twice as expensive as it was yesterday.” You get excited and say: “Great! I’ll take two of them!”
As Warren Buffett once said, investors should be fearful when others are greedy, and greedy when others are fearful. Of course it’s hard to resist when you see friends and neighbours making a killing on one sort of investment or another; it’s even harder to invest in an asset when others wouldn’t touch it with a barge pole. But realising our in-built tendency to buy and sell at the wrong times is the first step to doing something about it.
Photo copyright Andrew Magill